How Concerns About the Health of Midsize Banks ‘Evaporated’

We noted second quarter earnings reports last week, and the results have led The New York Times to call America’s regional banks “healthy again,” after first quarter bank failures and the resulting stress on the industry.

As midsize banks entered the second half of the year “their balance sheets look healthier than they did last quarter, with higher-quality loans and more money set aside to cover surprise losses,” the Times wrote. This strong showing proved some doubters wrong.

The numbers support the healthy diagnosis. The KBW Nasdaq Regional Banking Index, which plummeted 35 points during the industry stress, is now up around 27% from its mid-May low. And stock prices of banks with assets between $50 billion and $250 billion are up more than those for big banks, according to an analyst quoted in the story.

So how did the regionals rebound? While the economy being able to avoid recession (so far) has helped, the story points to three reasons:

• By spending more to attract customer deposits. Regional banks have offered higher interest rates—sometimes 5% or more—to lure depositors back and to keep existing customers from fleeing.
• By getting rid of unprofitable loans. Banks improved their credit quality by offering fewer auto loans, by refusing to renew loans for clients who don’t use other bank services, and by shedding stand-alone loans that don’t return their cost to capital.
• By preparing for the future. With rising interest rates at the crux of bank failures, and commercial real estate looking increasingly precarious, midsize banks are being vocal about their low exposure to those issues—for example, office real estate accounts for only 2-4% of their outstanding loans. Still, banks are adding funds to cover “surprise losses.”

According to Alexander Yokum, an analyst at CFRA, concerns that many had about the stability of regional banks “almost completely evaporated in the second quarter.”