Why Hundreds of U.S. Banks May Not Survive the Year

The Toxic Cocktail of Real Estate and Rate Hikes Let’s start with the consulting firm Klaros Group. According to its analysis of approximately 4,000 banks, 282 are trapped in a deadly embrace of high commercial real estate exposure and staggering unrealized losses resulting from the high-interest rate environment. These banks face the desperate task of seeking new capital or finding a buyer. But with the end of the Fed’s Bank Term Funding Program (BTFP) and no buyers in sight (as M&A activity has slowed to a crawl), these banks, all of which are starting to show cracks, don’t appear to have any viable lifelines left. More Rate Hikes on the Horizon? The Federal Reserve's aggressive stance, with 11 rate hikes through July and no signs of relief, has left a minefield of low-interest bonds and loans, ready to detonate under the banking sector's feet. This is the banking sector’s powder keg. There are hundreds of billions in unrealized losses on these banks' balance sheets. What if the Federal Reserve decides to continue its policy of increasing interest rates? Could this be the spark that ignites the powder keg, exacerbating the financial strain that triggers a series of defaults and banking failures? New York Community Bank emerges as the lone bank to date able to narrowly escape doom with a $1.1 billion lifeline from private equity investors led by ex-Treasury Secretary Steven Mnuchin. Yet, the majority of small banks might not be so lucky; particularly the community lenders with assets under $10 billion. Most lack the resources to secure similar bailouts, leaving them vulnerable to the harsh realities of a tightening financial landscape. Regulators to the Rescue? Regulators are actively addressing the vulnerabilities within the banking sector by confidentially ordering banks to bolster capital levels and staffing. But they face a considerable challenge: the need to stabilize a wide array of institutions that are hemorrhaging capital, exposed to high-risk commercial real estate, and struggling in a sustained high-interest rate environment. The slowdown in merger and acquisition activities also further complicates this process as well. It’s traditionally a key avenue to help bolster financial recovery and stability. But in the current predicament, it’s no longer a reliable solution. But another thing to note is that regulators are working behind the scenes to avoid causing panic or a loss of confidence that could lead to deposit runs. The public hasn’t quite caught wind of the situation. Imagine what would happen if it did. The Creeping Decay of Zombie Banks Brian Graham of Klaros whispers of a banking landscape awash with potential failures, a testament to the systemic rot that has set in. These community banks now risk becoming "zombie banks." Whether they bleed out slowly or rapidly in a bank run, the “necrosis” of the regional banking landscape has begun. Powell's Ominous Warning Over the American Banking System Jerome Powell, the Federal Reserve Chair, in a moment of candor, admitted to the gathering storm. Commercial real estate losses are likely to cause many of these small and medium-size banks to fail. As Powell told lawmakers: “There will be bank failures.” He did, however, also mention that it was manageable. It leaves anyone to ponder—might this be the “avoid causing panic” part of the Fed’s public messaging strategy? As liquidity evaporates and the "Problem Bank List" swells, the banking sector's woes deepen. The dismal M&A activity of the past year stands as a monument to the uncertainty and fear that grip the hearts of bank executives. Many aging bank CEOs, the weary leaders of these faltering banks, are now pondering their exit, leaving behind a vast armada of financial ship-of-fools on a collision course with the US economy. This is partly the outcome of the BTFP’s March 11 expiration. It may seem quiet now, but soon, the silence could shatter, plunging the unwary and unprepared into a cacophony of financial chaos and economic despair.