What’s up with these regional US banks? So many of them are growth stories nowadays with crazy stock climbs in a weak economy. And that was before the elections. The small banks seem to be jumping since then.
Well, you’re not just imagining this. As Thomas Michaud, CEO of the investment banking firm KBW said on CNBC’s 12/21/15 interview, “there is a rise of regional champions” going on with the high powered merger activity we are used to seeing in the large money center banks shifting dramatically the last couple years or so to the well run regional banks looking to grow. Some of these growth stories have been stunning with stocks tripling or more, defying commodities, China, junk debt, and lack of economic growth.
As rates rise, banks will certainly benefit from a return to its classic business model. But a big difference in this rate cycle could be our escape from the aberrant zero interest era. As explained in this article, the Fed is now paying interest to banks over the prevailing rate to keep the massive QE sums on banks’ balance sheets and out of lending into the economy to prevent inflation from going out of control. This amount will be $24 billion yearly if the Fed increases rates just once more. They are expected to do at least that. This was viewed as a problem back in 2013 as the commercial banks’ reserves held at the Fed ballooned to over $2 trillion as noted in the Wikipedia account on this feature of the Fed:
As the economy began to show signs of recovery in 2013, the Fed began to worry about the public relations problem that paying dozens of billions of dollars in interest on excess reserves (IOER) would cause when interest rates rise. St. Louis Fed president James B. Bullard said, “paying them something of the order of $50 billion [is] more than the entire profits of the largest banks.”
Banks are in a ZIRP induced sweet spot where they will, at a minimum, be collecting no risk interest ($34 million a day) no matter what happens in the economy – multiples of that if rates rise at all next year. This fallout from the Fed’s tom foolery with creating an artificial market in everything looks like a windfall for the banks. It has been described as a “subsidy” to lenders for doing absolutely nothing. There is another megatrend that makes this development more significant – the drastic shrinkage in the number of banks as featured in a Wall Street Journal piece. Since 1985, the number of U.S. banks has shrunk from 18000 to around 6500 while squeezing deposit assets up from $3 trillion to about $10 trillion.
The weak banks being gobbled up by the strong is making the players left fewer and stronger. On top of that, not all commercial banks get this interest from the Fed, just the ones who are Fed member banks. You have to meet certain qualifications for that, and only about one out of three are member banks. If you take the $34 million a day in Fed interest payments and do the simple math, that’s about $15000 a day for each surviving member bank, and will increase by multiples of $15000 for each rate increase by the Fed from here on. That’s about as safe as revenue growth gets in a market starved for safe revenue growth. This federally guaranteed largess is perhaps one reason why the fast growing “regional champions” are doing so great the last couple years. The Trump effect is looking to amplify all this. So we’re seeing the post election jumps in these stocks.
