Elevated Bank Failure Figure For 2017 So Far Is Not A Cause For Concern

-0.97%
Downside
193
Market
191
Trefis
JPM: JP Morgan Chase logo
JPM
JP Morgan Chase

Data compiled by the FDIC about U.S. bank failures shows a rather discomforting trend: 5 U.S. commercial banks have failed so far in 2017 – equaling the total number of bank failures for full-year 2016. This includes the failure of New Orleans-based First NBC Bank in late April. This single bank failure is expected to cost the FDIC more than $1 billion – making it the most expensive bank failure since two Puerto Rican banks went belly up in the aftermath of the economic downturn. [1]

While the sudden increase in the number of failed banks is definitely not good news, we believe that there is no reason to push the panic button. The recent trend appears to be a side effect of the Fed’s decision to steadily hike benchmark interest rates, as the banks that failed were primarily those that catered to low- and middle-income customers. This is because higher interest rates are likely to trigger loan losses for these banks as customers fall behind on their repayments. While this means that the trend may continue as the Fed sticks to its rate hike policy, overall improvement in profits for the industry and an increase in consolidation will very likely keep failure rates low.

A Quick Look At Banking Industry Trends Since 2000

Relevant Articles
  1. Up 38% Since The Start Of 2023, What Is Next For JPMorgan Stock?
  2. Up 6% In The Last Six months, What’s Next For JPMorgan Stock?
  3. JPMorgan Stock Topped The Consensus In Q2
  4. What To Expect From JPMorgan Stock?
  5. What To Expect From JPMorgan Stock In Q1?
  6. Is JPMorgan Stock Fairly Priced?

The U.S. banking industry has seen a steady reduction in the total number of commercial banks for well over three decades now, as this figure fell from a peak level of 14,400 in 1984 to 5,031 at the end of Q1 2017. [2] This has primarily been due to consolidation in the industry, with banks looking to improve profitability through economies of scale. However, an important factor behind this decline since the economic downturn has been elevated levels of bank failure.

According to the FDIC’s list of failed banks, a total of 557 U.S. banks have failed since 2000. More than 80% of these banks failed in the four-year period between 2009 and 2012, which immediately followed the economic downturn.

AB_QA_FailedBanks_170526

* 2017 figures are up to 25th May

The FDIC reported an average of 4 failed banks each year over the 10-year period 1998-2007, before the recession resulted in the figure jumping to almost 100 a year over 2008-2012. This includes the failure of Washington Mutual at the peak of the economic crisis – the largest in U.S. banking history – which forced the FDIC to step in and broker a deal for the bank’s purchase by JPMorgan Chase (NYSE:JPM). A majority of the banks that went belly up after 2008 were focused on the mortgage industry, and they went bankrupt from losses they incurred when the mortgage bubble burst. Banks that retained their strength through the downturn used the opportunity to acquire distressed banks at bargain rates. U.S. Bancorp (NYSE:USB) stands out in this regard, as it acquired 14 different failed banks from the FDIC over 2008-12 – higher than any other bank in the country. More recently, the First Citizens Bank has been following a similar growth strategy with its acquisition of 5 failed banks since 2015.

What To Expect Going Forward

Steady improvement in economic conditions in the U.S. has helped the banking industry recover considerably over the years. But the smaller banks still remain at risk due to the stricter regulatory requirements that have been in place since the downturn. While the low interest rate environment has weighed on profits for the banking industry as a whole, it also led to a rapid growth in loans. A positive outlook also resulted in more relaxed lending standards by the banks over recent years. And this will lead to higher loan charge-off rates as interest rates normalize in the near future. This, in turn, should lead to an increase in merger activity across the industry going forward. Notably, the number of mergers among commercial banks has risen steadily since 2009, with the largest being the acquisition of Wachovia by Wells Fargo (NYSE:WFC).

Another reason we believe bank failures are unlikely to be a major issue over coming years is the fact that the number of banks categorized by the FDIC as problematic (i.e. banks that are at a risk of failure) has shrunk steadily from a peak level of 884 at the end of 2010 to just 112 now. This has resulted in the value of assets held by problematic banks falling to $24 billion from more than $400 billion in 2009.

Overall, we believe that the Fed’s rate hike process is undeniably a catalyst for growth for the U.S. banking industry with the increased risk to some of the smaller banks being an acceptable side effect. As profits for the industry improve steadily, merger and acquisition activity should ensure that assets of the at-risk banks are absorbed before they actually fail.

See the full Trefis analysis for U.S. Bancorp | Wells Fargo |  JPMorganBank of America | Citigroup

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

Notes:
  1. Louisiana Bank Failure Is Costliest Since Financial Crisis, U.S. News, Apr 28 2017 []
  2. Commercial Banks in the U.S., Federal Reserve Bank of St.Louis []