A decade on from the sub-prime mortgage crisis, the US’s regional lenders are using their ample capitalisation as a springboard for acquisitions and digital initiatives. Jane Monahan reports.

Fifth Third

Banks, generally, are thriving in the US, 10 years after the financial crisis (see chart). But bankers, regulators and analysts say it is a particularly positive time for the country’s 20 or so regional banks, which lie between the thousands of small community banks and the largest global banks. 

Wayne Abernathy, executive vice-president for financial institutions, policy and regulatory affairs at the American Bankers Association, is unequivocal. When asked: “Are regional banks in a good place at present?’ he replies: “They have never been so well capitalised and never had such a clean balance sheet. These are all the survivors, the ones that came out of the Great Recession stronger than when they went in.”

They are also among the biggest winners from the lower corporate tax rates resulting from legislation passed in December, and, like other banks, they have prospered from improvements in the economy including earning more for their loans as a result of higher interest rates. Regional banks’ total loans also increased 4% on average in the first quarter of 2018 compared with the same period in the previous year. 

Legal moves

Added to this, regional banks benefit from regulatory easing in two areas. The first, passed with rare bipartisan support ahead of November’s congressional elections, institutionalises changes that had already begun to be implemented, making the post-crisis 2010 Dodd-Frank Act’s strictest regulatory framework – including full-blown Federal Reserve Comprehensive Capital Analysis and Review (the annual stress tests) – largely the preserve of the biggest banks. Even before Donald Trump took office in January 2017, it was recognised, not least by the Federal Reserve, that correlating systemic risk and applying the same capital and liquidity requirements to the biggest US banks as those with $100bn in assets or less, did not make sense for the smaller banks either in terms of their risk profiles or the cost to the banks complying.

So under a new law, which Mr Trump signed on May 24, the threshold at which banks are deemed systemically important is raised from $50bn in assets to $250bn. Regional banks with less than $100bn in assets are freed from the Fed’s annual stress testing and enhanced scrutiny immediately. Thirteen larger regional banks with assets of between $100bn and $250bn may or may not be subject to extra regulatory scrutiny based on the Federal Reserve’s discretion.

The second instance of regulatory easing is the Fed’s proposed lowering in the amount of common equity Tier 1 (CET1) capital regional banks are required to hold as a cushion against potential economic and financial shocks. The new Federal Reserve Stress Capital Buffer rule was proposed in April and is expected to take effect at the end of 2018.

None of this means that regulators or bankers want to turn the clock back, regional bankers argue. “Those who say you are perhaps not remembering the lessons of the past are not giving credit for what I call the intervening decade of significant enhancements and new policies and procedures that have taken hold at banks, as well as the level of capital that has been generated in banks through profitable and prudent growth,” says Beth Mooney, chair and chief executive of KeyCorp, based in Cleveland, Ohio, with a footprint covering states from Alaska to Florida and $137bn in assets. “What we have built doesn’t go away. To me it’s returning some piece of responsibility of managing capital back to boards and management.”

US banking metrics 0618

NPLs stay low

Some have expressed concern, though, about the timing of the Trump administration’s pro-growth tax and deregulation measures, coming as they do towards the end of a prolonged recovery. When the economic cycle may be about to turn, as interest rates and inflation have started rising and, according to the International Monetary Fund, loans to highly indebted US companies in 2017 have exceeded the pre-crisis peak.

For the time being, however, regional bankers are not anxious. US banks’ overall non-performing loan (NPL) rate fell to 1.34% in the first quarter of 2018, a record post-crisis low, and all the regional banks contacted for this article reported total NPL ratios of less than 1%.

“As rates go up, one of the good things is that the Fed is being very gradual in taking away, if you will, the punchbowl,” says Bruce Van Saun, CEO and chairman of Citizens Financial Group, which is based in Providence, Rhode Island with a footprint in 11 states and $153bn in assets. “There’s a certain amount of predictability to when rates are going up that allows households to get in front of that and manage through that… and for levered companies as well to be able to lock in fixed-rate swaps if they want, to hedge against interest rate risks.”

Regional bankers are not disregarding the uncertainties that may lie ahead, however. “We’re getting to the long end of this recovery,” says Greg Carmichael, CEO and chairman of Fifth Third Bancorp, which has $142bn in assets and operations in 10 states. “We’re very mindful of where we are and we’re very disciplined. Because of that discipline, we are getting the right returns on our capital and making sure we are well positioned through a downturn cycle. We deliberately exited a total of $5bn in commercial loans in 2016 and 2017 that did not meet our risk appetite or return profile. We also reduced our indirect auto loan origination from $5bn to $3bn, but have since brought that origination back up to about $4bn as returns improved.”

Such discipline, however, has not stopped Fifth Third Bancorp from continuing to grow by acquisition. Indeed, in May the bank announced a $4.7bn takeover of $20bn-asset Chicago-based lender MB Financial.

In a conference call with analysts, Mr Carmichael said the merger would enable Fifth Third Bancorp “to build scale” in Chicago by expanding its medium-sized companies portfolio, while offering an opportunity to significantly cut costs. Commentators said the merger proceeded in part because of Fifth Third’s high share price, which rose 41% in the 12 months before the announcement, making it possible for the bank to pay MB Financial with 90% stock and only 10% cash. Another motive, analysts believe, is excess capital. Fifth Third has a CET1 capital ratio of 10.8%, significantly higher than the 9.5% medium- to long-term target that Mr Carmichael believes the bank needs to meet all regulatory requirements.

Despite paying a 27% premium for the acquisition, based on MB Financial’s share price in April, Mr Carmichael told analysts there would be no change to Fifth Third Bancorp’s 2017 plan to return a significant amount of capital to shareholders. The latter, together with increased lending and capital investments, is the main way for regional banks to deploy their record profits and excess capital.

Adding assets

Another big merger, announced in 2016 but approved in 2017, is KeyCorp’s $4.1bn cash and stock acquisition of First Niagara Bank, based in Buffalo, New York, which Ms Mooney says will enable KeyCorp to strengthen its position in upstate New York and New England, and give it a presence in Pennsylvania for the first time. It will also help the bank achieve more of a balance between its commercial and retail businesses. “Attractively for us, it brought us a residential mortgage platform that we were trying to re-build, as well as auto lending assets,” says Ms Mooney.

As rates go up, one of the good things is that the Fed is being gradual in taking away, if you will, the punchbowl

Bruce Van Saun

Looking ahead, Ms Mooney says KeyCorp is not planning to make any more acquisitions of large institutions but may expand particular businesses and capabilities by acquiring talent or firms. For example, in 2017 KeyCorp bought boutique, healthcare-focused investment bank Cain Brothers to increase KeyCorp’s offerings to middle-market clients in the healthcare sector, one of six manufacturing and industrial sectors that KeyCorp services at a national level.

Citizens Financial Group’s point of departure is different. Due to the travails of Royal Bank of Scotland (RBS) – Citizens was spun off from RBS in September 2014 – for several years the bank has had to focus on deleveraging and downsizing, to raise its capital ratio and conserve funds.

“Much of the past five or so years have been oriented towards defence-type spending,” says Mr Van Saun. “It was 75% defence, 25% offence. But we’re actually starting to move away from that. The overall plan is to grow the bank, get back to optimal size and invest in some capabilities that during the RBS days we didn’t have the wherewithal to make. Our goal is to grow our revenues 3% to 5% faster than our expenses.”

Amply fulfilling that, in 2017 Citizens Financial’s revenues climbed 10% while expenses grew 3%. “That spread really powers your profitability,” says Mr Van Saun.

Points in common

But while the approaches, growth strategies and areas of specialisation vary, there are also commonalities between these big regional banks.

First, they offer a full range of retail and commercial banking products and services, including credit cards, mortgages, auto and personal loans, alongside investment banking products and services for industrial, corporate and institutional clients (including debt placements, syndications, equity underwriting and mergers and acquisition advisory).

“We have the products of the big guys but the delivery models of a community bank,” says Fifth Third Bancorp’s Mr Carmichael.

KeyCorp’s Ms Mooney adds: “It’s a very competitive positioning, because you are large enough to have products and capabilities that customers across a broad range need, but you are still small enough that you can deliver them in a very individualised and nuanced way, and be nimble.”

Second, according to the CEOs, a fundamental aim of a regional bank is establishing long-term profitable relationships with customers and businesses by providing comprehensive solutions to meet all their financial needs.

“It has been demonstrated that when you have a holistic relationship, even during a downcycle, those relationships remain very profitable,” says Mr Carmichael. “If you just have a credit relationship, those things tend to create more risks for a bank when the cycle turns. It lowers your return profile on that relationship. So we’re very focused on relationship banking, not just a balance sheet perspective.”

Third, in their commercial banking, big regional banks focus on the US’s 200,000 or so medium-sized companies with revenues of between $10m and $1.5bn, many of them family owned, which produce roughly one-third of the US's gross domestic product.

I think customers value that they are more embedded in their relationships with their regional banks

Beth Mooney

A so-called 'super regional bank' is one that does business at a national level beyond its traditional regional service area. This started with providing banking to verticals, national industrial sectors such as healthcare, retail, energy and defence, which has given these banks industry-specific expertise.

But as the targeted middle-market companies have become more sophisticated in their needs, regional banks have been forced to ramp up their capabilities.

Raising their game

One such capability is in fee-earning in capital and international markets banking. For example, Ms Mooney says KeyCorp’s investment banking and debt placement fees had developed into “an $800m-a-year” business in 2017.

Technology is another area where scale is important to compete with the biggest US banks. The 'super regionals' are finding success here too. According to Mr Van Saun, much of Citizen Financial’s digital technology investments over the past few years have been in data and analytics, making it a leader in the field.

This allowed the bank to pioneer an educational refinancing initiative where the bank offers graduates, burdened by debts accumulated during their university years, the possibility of consolidating those debts into a single loan, but at a considerably lower interest rate, reflecting their credit profile improvements, five or six years later, by which time they are gainfully employed. The offering is a project of an all-digital national lending division, targeted at young people, that also offers mortgage, auto and personal loans.

Also providing savings, though in a commercial banking context, Fifth Third Bancorp recently invested in Transactis, enabling the bank to offer business clients back-office automated alternatives to replace their paper billing and payments processing. “It’s a complete digitalisation of the accounts payable process,” says Mr Carmichael. “There is a tremendous efficiency that will be derived from that, and cost take-out. We want to provide that kind of solution.”

Against this background, one new and potentially significant challenge for regional banks is that with rising interest rates, competition is increasing between banks over deposits, as savers and businesses start looking for more alternatives to earn a better yield for their money.

A valued relationship

Regional banks have begun to pay more for the deposits of their most rate-sensitive commercial clients and wealthy customers, which have been falling. But so far the core deposits of mass retail accounts, which are small in size, have hardly moved. Ms Mooney says one reason for the inertia is because most of these customers still remember the financial crisis, and hence the safety of their money matters. Also, banks are not yet aggressively raising rates as there is sufficient liquidity relative to loan demand within the system. Third, she says: “I think customers value that they are more embedded in their relationships with their regional banks so they are not going to look around for 10 basis points more here or there for their deposits or some special offer. They value those relationships.”

But given the biggest US banks’ extensive distribution networks and deeper pockets to pay more for deposits and marketing campaigns, regionals do not believe this is a time for complacency.

Citizens Financial Group, in an attempt to get ahead of the curve, has announced an all-digital nationwide deposit platform for later in 2018, Citizens Access, with attractive rates and in a lower cost format, to help digitally savvy customers make savings in a simple and secure way.

“It’s one of the things banks can do as a result of the new tax bill,” says Mr Van Saun. “There’s a little higher appetite in all companies to do more capital expenditure investment.”


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