With regulatory relief in sight, midsize banks across the US are tapping into new sources of revenue.
Expectations for lower corporate taxes and an easing of regulatory pressure on the finance industry under President Donald Trump bode well for midsize regional banks and their commercial clients across the US. Lower corporate tax rates are expected to free up capital for small and medium-sized businesses to reinvest. And banks that were approaching $50 billion in assets may no longer need to merge with larger ones—or acquire smaller ones—to raise the capital required to meet the costs of compliance, according to Chris McGratty, an analyst who specializes in regional and community banks at investment bank Keefe Bruyette & Woods (KBW) in New York.
At the same time, it’s particularly timely, as midsize regional commercial banks are coming under tremendous pressure to make ends meet. Top-line revenue growth has been slow in recent years at commercial banks—and even stagnant at some, according to Boston Consulting Group (BCG)—as costs continue to rise because of inflation and compliance with the latest banking regulations under the international Basel III accord and the domestic Dodd-Frank financial reform law. Making matters worse, loan losses crept up in 2015 from near-zero lows a year earlier. Meanwhile, the larger national banks have been investing in online commercial banking products that attempt to emulate the “single point of service” model for which small and midsize clients have historically been willing to pay their regional banks a premium. Some clients have already voted with their feet.
“The call to action is increasing,” says Pieter van den Berg, a consultant at BCG who works with midsize banks in the US. “We are seeing banks in a large-scale transformation, changing the way they do business. There is more of a sense of urgency, as the client base has gotten more harsh.”
In a glaring sign that transformation is a priority for regional banks, the industry’s once brisk pace of consolidation slowed last year, when about 240 mergers were reported. KBW had predicted more than 300 deals among banks that wanted to build up their scale to absorb rising compliance costs as their respective asset bases grew to the critical level of $50 billion, the point at which the Fed would designate them systemically important financial institutions (SIFIs). One reason for the slowdown was that, as of 2016, fewer banks were still willing to acquire other banks and leave them alone without sacking their staff or consolidating their operations.
Consolidation has led some regional banks to expand outside the home region, where they have spread their risk by making small loans to small companies in a diverse array of industries from manufacturing to agriculture to scrap metal—some of which thrive in cyclical downturns while others suffer. One bank that is eagerly expanding outside its home base is UMB Financial Corporation, which has long kept a diverse corporate portfolio of small and medium-sized clients in different industries in its native Kansas City, Missouri. UMB has been moving across the southwest US since 2015, when UMB acquired Marquette Financial Companies. The acquisition stepped up UMB’s profile in two of the region’s biggest corporate banking markets—the cities of Phoenix and Scottsdale in Arizona, and Dallas/Fort Worth in Texas. As part of the deal, the bank picked up various specialty businesses elsewhere in the US.
“As we look ahead, we will continue to be opportunistic about acquisitions and expansions,” says Mike Hagedorn, vice chairman of UMB Financial and president and CEO of UMB Bank.
Another strategy is to specialize more deeply. SunTrust Bank, for example, historically lent to small and medium-sized companies in industries concentrated around its headquarters in Atlanta, Georgia. These are mainly logistics businesses operating in the ports of Georgia and neighboring states; life sciences and other technology research companies in the Research Triangle of North Carolina; and nursing homes and retirement centers in Florida and elsewhere in the Southeast. Over the last couple of years, SunTrust has hired specialists to raise money for these clients on the stock and bond markets. Last year, the bank stepped up its game in biotechnology, hiring professionals in equity research, equity origination, M&A advisory and investment banking.
“These specialists help identify ways that SunTrust services and products can provide support to the growth strategies of those companies,” says Mark Chancy, wholesale banking executive at SunTrust.
On December 16, SunTrust took a great leap into commercial real estate, an industry in which the bank had only about 8% of its total loans outstanding, when it closed on its acquisition of Pillar Financial, a real estate finance company headquartered in New York. The Pillar deal included agency licenses for Fannie Mae, Freddie Mac and the Federal Housing Administration, making SunTrust an agency lender overnight. The deal also included a lending business with specialty teams focused in areas such as multifamily apartment buildings, healthcare properties, senior housing and manufactured housing. It even included a commercial real estate investor services business and a mortgage brokerage in Chicago. Now the bank has filled a gap that had prevented it from serving an important client in the multifamily apartment business, Chancy says.
There are risks to these strategies, of course. When the UK voted last summer to secede from the European Union, the surprise prompted Silicon Valley Bank of Santa Clara, California, to view its 4-year-old London branch in a whole new light. The full-service branch had opened in June 2012 as a gateway to continental Europe, where Silicon Valley Bank had been providing early-stage technology entrepreneurs with financing. Now the bank is likely to repurpose the branch to focus on tech entrepreneurs in the UK, which is expected to become more economically isolated by the cancellation of “passporting” rules that have allowed EU nationals to work and travel in the UK.
Silicon Valley Bank is focusing on fintech, which tends to be concentrated in the UK, says Daniel Drancik, the bank’s head of global treasury, trade and payments advisory. For its next international expansion, Silicon Valley Bank is looking north on its home continent, says Drancik: “We have been very interested in Canada. We have offices in Boston and Seattle, and that is a natural area for us to expand into.”
On the regulatory front, however, relief may be in sight. A major source of headaches for midsize banks—the cost of compliance—could fall. This process was set in motion May 2015 with the “Shelby Bill,” a deregulatory measure sponsored by Senate Committee on Banking, Housing and Urban Affairs chairman Richard Shelby that would allow banks to remain undesignated as SIFIs until they accumulate $500 billion in assets, up from $50 billion now. “What we have heard from president Trump is that he has a vision to significantly reduce regulation, which could financially benefit many sectors from finance to energy,” says UMB’s Hagedorn. During the first two months after the election, financial stocks were up 18%, which Hagedorn regards as “sending the message” that banks will benefit from a lighter regulatory burden.