Will Small Loans Be the New Thing for Big Banks?

As the cost of deposits increases for smaller banks, will big banks make a run at the small to medium-sized loans the smaller banks have been providing?

The 2008 financial crisis saw banks—big and small—in trouble. The federal government taught this country that it’s one thing if a community bank fails—and it’s an entirely different story if a big bank does.

The Fed’s actions squarely cemented their flag in the “too big to fail” camp.

Back to 2008

Each of the following banks received a direct or indirect bailout through TARP (Troubled Asset Relief Program) because of the 2008 financial crisis (CNN)

1. Bank of America
2. Citigroup
3. Goldman Sachs
4. JPMorgan Chase
5. Wells Fargo
6. Morgan Stanley
7. AIG
8. GMAC (now Ally Financial)
9. Bank of New York Mellon
10. State Street

In addition, 507 banks reportedly went under between 2008-2014. Most of us couldn’t name but two or three of them. Still, the big ones catch the headlines. Here are the top 10 bank failures of the 2008 financial crisis.

1. Washington Mutual ($307 billion in assets)
2. IndyMac Bank ($32 billion in assets)
3. Colonial Bank ($25 billion in assets)
4. Guaranty Bank ($13 billion in assets)
5. First National Bank of Nevada ($3.4 billion in assets)
6. ANB Financial ($2.1 billion in assets)
7. Silver State Bank ($2 billion in assets)
8. Integrity Bank ($1.1 billion in assets)
9. First Priority Bank ($825 million in assets)
10. Corn Belt Bank and Trust Company ($347 million in assets)

Too big to fail? Only one was in the S&P 500: Washington Mutual. By comparison, Silicon Valley Bank (SVB), a recent bank failure, had $209 billion in assets on Dec. 31, 2022.

The banking industry has and is changing. According to the FDIC, in 2000, there were 8,315 commercial banks; by the end of 2020, there were only 4,379. With increased regulation post-2008 came increased costs associated with running a bank. To survive, a bank must be of a certain size, which entails additional pressure on community banks.

All this adds up to one word: consolidation.

The Ripple Effect of SVB

SVB experienced a liquidity crunch. In a matter of hours, as the word spread and depositors made a run for their cash, the bank became insolvent. The FDIC exists to provide both confidence and a backstop to depositors, but their coverage is limited to $250,000. Any amount above that is uninsured.

What percentage of deposits at SVB were uninsured? Not 75%. Not 85%. Not even 90%. S&P Global Market Intelligence clocked their uninsured deposits at 93.8% of total deposits at the end of 2022. After the collapse, the FDIC immediately expanded its coverage to all deposits at SVB.

You are left to ponder if the FDIC would have been so kind to your regional bank down the street. When comparing your community or regional bank to SVB (a bank with powerful business and political ties), you may conclude the FDIC would have been (and will be) much less generous.

What actions are people taking? They are moving their money from community and regional banks to those the federal government proved, in 2008, were too big to fail. Small to medium banks in the U.S. “lost $120 billion in deposits, or 2% in the week of SVB’s collapse,” according to the Federal Reserve. Over half of those $120 billion in deposits went straight to the nation’s largest banks.

Disproportionate to their size, small and medium-sized banks account for a large share of U.S. real estate loans. Goldman Sachs reports that “lenders with less than $250 billion in assets account for roughly 50% of U.S. commercial and industrial lending, 60% of residential real estate lending, [and] 80% of commercial real estate lending.” If you own real estate, there is a high likelihood you bank (or at least have loans) with a smaller bank. You and I need to pay attention to what’s unfolding.

Banks need deposits to lend and turn a profit.

A Dangerous Pattern

As their deposits recede, regional and community banks will be forced to “buy” deposits through more expensive measures such as running CD specials. They might realize losses in their bond portfolio to get liquidity and then sell notes to other banks to balance their ratios, thus shrinking the size of the bank. The “buying” of deposits will increase their average cost of capital. When they add their margin to their average cost of funds, you may find yourself shell-shocked to hear their rate quote. It will have increased beyond step-lock with the five-year Treasury.

Remember the $120 billion in deposits withdrawn the week of SVB’s collapse? The opposite side of that coin is that big banks have deposits rolling in from depositors seeking to reduce their perceived risk to their cash accounts. These deposits are not limited to individuals. Businesses are moving in a big way.

Businesses, as a whole, operate well beyond the FDIC limit of $250,000. Faced with the idea of having several million at risk, many businesses have moved their deposits. As big banks’ deposits grow, their cost of funds drops.

Very quickly there may be a vicious pattern emerging for small banks.

Big Bank Blue Ocean?

The million (and billion) dollar question is: Will big banks make a run at the small to medium-sized loans that community banks have been providing for years? Business owners and real estate investors have come to enjoy how easy it is to deal with a smaller bank, localized underwriting, and the fact that you can meet with your lender over lunch.

We may all soon be faced with doing business a new way (i.e., with big banks) or paying up to get the deal done with bankers we know, like, and trust.