Two regional banks emerged as winners last year as deposit runs shook their industry. Their fortunes have diverged since: New York Community Bancorp Inc. required a frantic rescue last month. First Citizens BancShares Inc. has stretched its rally to more than double in value.
But behind the scenes, even the stock-market winner has to deal with the growing pains that have come to define a group of lenders big enough to warrant greater scrutiny from watchdogs, yet still far smaller than their megabank rivals.
First Citizens, which bought Silicon Valley Bank a year ago, is privately trying to satisfy demands from the Federal Reserve including bolstering its internal governance to better fit its rapid growth, according to people with knowledge of the matter.
The concerns at First Citizens have been less severe than the pressure that bore down on NYCB this year — ultimately forcing that firm to raise more than $1 billion in capital — and are more in line with an industrywide crackdown following last year’s failures. The situation underscores the difficulty regional banks face as they grow, especially through acquisitions.
How thousands of regional banks and their various watchdogs navigate the situation will have broad implications for the future of American finance. Small banks need to merge and bulk up so that they can compete with the industry’s too-big-to-fail giants. But to do that, executives face myriad challenges: capital rules that become more stringent as balance sheets grow, divergent approaches by regulators and an unforgiving market for lenders that make missteps along the way.
“The toughest spot to be in is to be a bank between $50 billion and $250 billion, because you’re suddenly subject to these much heavier regulatory burdens and you’re not anywhere near as big as a JPMorgan or Wells or BofA or what have you,” Brian Graham, founder and partner at financial-services advisory firm Klaros Group, said in an interview. “You’ve got a much higher fixed cost of running your business. That’s going to drive you to be bigger, but it’s really hard to grow organically and it’s going to be very challenging to grow through M&A given regulatory skepticism.”
The first major hurdle arises for lenders that approach $100 billion in assets. That’s when they have to deal with a key regulatory threshold, becoming so-called Category IV banks, which are subject to stiffer capital rules and oversight. Those banks may face a new raft of rules if proposals around long-term debt and the Fed’s discount window are approved.
That transition has proved difficult for bank executives used to lighter-touch supervision from regulators who don’t tend to require the sort of sophisticated risk and compliance processes common at large national lenders. And banks can’t be given too much time to make the transition, particularly after the Fed’s internal watchdog faulted the central bank’s examination approach for SVB in a report last year, saying supervisors were too slow to recognize problems and demand fixes in months preceding that firm’s failure.
Michael Barr, the Fed’s vice chair for supervision, vowed that his team would act faster and more forcefully. Within months, the central bank had issued a slew of private warnings to banks with between $100 billion and $250 billion in assets, Bloomberg News reported last August. For individual banks, the new scrutiny, plus earnings pressure tied to higher deposit costs, brought a decade-old question back to the fore: how big is big enough?
First Citizens bought CIT Group Inc. in early 2022, bringing it across the $100 billion threshold, and then nearly doubled in size overnight when it bought SVB last year. That put it within striking distance of Category III, which begins at $250 billion and elicits even more scrutiny.
The Raleigh, North Carolina-based firm, which counts three family members among its seven-person senior-management team, has been bolstering its top ranks in recent months. It appointed Toronto-Dominion Bank veteran Gregory Smith chief information and operations officer, and added a former vice chair of Bank of America Corp. to its board of directors.
The firm has made “regulatory readiness a top strategic priority,” Chief Executive Officer Frank Holding Jr. said on the company’s quarterly conference call in January.
“First Citizens Bank has maintained strict compliance with all regulatory requirements and will continue to do so as our growth moves the bank to a higher level of regulatory oversight,” spokesperson John Moran said in a statement Wednesday. “We have made meaningful progress in continuing to refine and mature our processes to support the change in First Citizens’ size and complexity.”
A representative for the Fed declined to comment.
The number of banks in the US has dropped almost every year since 1984, when there were 14,496, and now hovers just under 4,500, according to Federal Deposit Insurance Corp. data. But a gap has formed: While mega-banks JPMorgan Chase & Co., Bank of America, Citigroup Inc. and Wells Fargo & Co. took shape in a frenzy of deals in the 1990s and early 2000s, other firms haven’t been able to follow suit.
Instead, stricter rules after the 2008 financial crisis have made major bank mergers more difficult — and, under certain circumstances, impossible. So the biggest banks have capitalized on their head start by using their clout to attract more customers, while the rest of the industry falls further behind.
Merger Pressure
Giants such as JPMorgan and Bank of America now pour billions a year into technology that lowers their costs while broadening their reach, pressuring smaller banks to seek more scale to keep up. For those firms, the pressure to merge has only increased in the past year, with banks eager to hold onto deposits forced to pony up more for them while simultaneously having to pay up to satisfy regulators’ demands.
It’s something of a Catch-22 for regional-bank chiefs: getting bigger softens the blow of some of those higher expenses, but — as demonstrated by First Citizens and NYCB — growth comes with a new level of scrutiny that drives costs up even more.
The issue is impacting regional banks across the size spectrum: U.S. Bancorp, facing more stringent regulations after its acquisition of Mitsubishi UFJ Financial Group Inc.’s Union Bank, agreed last year to shrink its balance sheet and reduce its risk profile to avoid moving into Category II, which begins at $700 billion in assets. Investors cheered the move, sending shares up 7% the day it was announced.
“Regulators seem determined to chill regional bank M&A, which is exactly the wrong approach if you want to avoid failures by allowing stronger banks to acquire weaker ones,” said Sheila Bair, former chair of the FDIC. “Longer term, growth among regional banks is a good thing if it brings more competition, greater diversification and more-sophisticated risk-management capabilities.”
Yellen, Powell
It’s unclear at this point how such deals would go over in Washington. Some officials have signaled openness, including US Treasury Secretary Janet Yellen and Fed Chair Jerome Powell, both of whom have said more combinations are inevitable in cases where a midsize lender faces stress.
On the other hand, banking and antitrust watchdogs have proposed new rules that would likely throttle more bank tie-ups in a bid to stamp out potential competition risks. For such skeptics, the recent turmoil at NYCB serves as an example.
At that firm, three different regulators in as many years had an unusually deep impact on its evolution as it doubled in size. The New York State Department of Financial Services and the FDIC had been overseeing NYCB for years. When the lender agreed to buy Flagstar Bancorp Inc. in 2021 — a deal that would vault the combined firm close to the $100 billion mark — Acting Comptroller of the Currency Michael Hsu pushed for his agency to take over supervision, according to a person familiar with the discussions.
Representatives for the OCC and NYCB declined to comment.
The NYCB-Flagstar deal finally went through in late 2022, with the OCC taking over supervision. A few months later, hometown rival Signature Bank failed, and the FDIC awarded parts of that lender to NYCB.
As OCC supervisors conducted their first annual round of examinations into the bank — which had, by that point, crossed the $100 billion mark — they took issue with its risk management and oversight. Notably, the portfolio of multifamily-property loans that the OCC found most worrisome had long been held by NYCB, rather than being inherited in its recent acquisitions.
Under pressure from the OCC, NYCB shocked investors in January by slashing its dividend and reporting a fourth-quarter loss. Shares began a downward spiral that culminated last month with a capital infusion from a group led by former Treasury Secretary Steven Mnuchin. He installed old ally and former Comptroller of the Currency Joseph Otting as CEO.
On a conference call the day after the capital injection was announced, Otting assured investors that he will “continue to build on our regulatory and compliance focus” — and evaluate shrinking the firm back under $100 billion.
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