As Interest Rates Soar, Funding Costs Surge... US Small and Mid-Sized Banks Face Q3 'Earnings Shock'

Kikoff's Q3 Profit Down 44% YoY
Small and Mid-sized Banks' Deposit Rates Rise from 0% Last Year to 2% This Year
Deposit Interest Payments Triple Due to Increased Funding Costs

Profits of small and medium-sized banks in the U.S. significantly declined in the third quarter of this year. While earnings are expected to increase during periods of rising interest rates, these banks faced an earnings shock due to higher funding costs and the decline in the value of bonds purchased during low-interest-rate periods.

According to the Wall Street Journal (WSJ) on the 23rd (local time), profits of major U.S. small and medium-sized banks in the third quarter of this year decreased by double-digit percentages compared to the same period last year. KeyCorp's profits shrank by 44% compared to a year ago, while Citizens Financial and Truist Financial saw declines of 32% and 28%, respectively, during the same period.

The large cost of attracting deposits had a significant impact. According to WSJ, the average deposit interest rate of major regional banks rose from around 0% in the third quarter of last year to over 2% in the third quarter of this year. Some banks, finding it difficult to raise all necessary funds through deposits alone, attracted deposits through third-party intermediaries or borrowed funds from the Federal Reserve (Fed). These methods typically involve higher costs. As a result, interest payment expenses for banks such as U.S. Bank, PNC, Truist, and KeyCorp increased by approximately 300% compared to the same period last year.

This is the exact opposite of the usual trend where profits increase due to expanded net interest margins during periods of rising interest rates. Banks typically raise loan interest rates faster than deposit rates during rate hikes to expand net interest margins. However, small and medium-sized banks faced difficulties in funding, leading them to rapidly increase deposit rates, which in turn caused a decline in earnings. The Federal Reserve raised the benchmark interest rate from 0-0.25% in March last year to 5.25-5.5% through 11 consecutive hikes at an unprecedented pace.

The preference for safe assets such as bonds also had an impact. With the Fed signaling prolonged high interest rates and the U.S. 10-year Treasury yield recently surpassing 5%, rising sharply since August, investors shifted their focus from deposits to higher-yielding bonds or money market funds (MMFs). Analysts also suggest that the aftershocks of the Silicon Valley Bank (SVB) collapse in March last year are still ongoing.

Small and medium-sized banks are now downsizing to defend against the earnings shock. KeyCorp announced plans to lay off thousands of employees, and Truist plans to reduce other low-yield assets after selling student loan assets. Citizens Financial has stopped its auto loan business and continues to shrink its mortgage business.

Despite these self-help efforts, worsening conditions surrounding small and medium-sized banks have pushed some toward mergers and acquisitions (M&A). According to S&P Global Market Intelligence, there were a total of 34 bank M&A deals completed in the third quarter of this year, with deal values reaching $3 billion. This is nearly five times the $630 million worth of bank M&A deals completed in the first and second quarters of this year.

The market expects an increased likelihood of loan defaults due to prolonged high interest rates and a slowing U.S. economy. In particular, small and medium-sized banks have high exposure to commercial real estate loans, which are considered a potential risk trigger in the U.S. financial sector, raising concerns about the possibility of a second SVB-like crisis. Darryl Bible, CFO of M&T Bank, stated, "The economic impact of the rate hikes has not yet fully materialized," adding, "More stress could occur."

This content was produced with the assistance of AI translation services.