For some US banks, it’s still a wonderful life

NEW YORK, April 13 (Reuters Breakingviews) - Even after a string of financial failures that sent depositors running for the hills, it's a good time to be a giant U.S. bank. Perhaps counterintuitively, it's also a good time to be a small one. As for those who sit in the middle, it's the worst of all worlds.

Big lenders like JPMorgan (JPM.N) and Wells Fargo (WFC.N) are likely to say their deposits shrank year-on-year when they disclose their most recent results on Friday. Along with Bank of America (BAC.N), which reports next Tuesday, analysts polled by Refinitiv expect they will have lost a combined $500 billion or so of customer funds. All things being equal, leaking deposits is a pain for banks, since customers' balances are the cheapest kind of funding there is, especially because many of them sit in transaction accounts paying zero interest. A bank can borrow depositors' money for free, then lend at a profit - a gap known as the net interest margin.

There's an extra frisson to deposit movement this quarter, since it was a sudden withdrawal of customer funds that felled SVB Financial and Signature Bank last month. But big lenders already expected to see some funds head out of the door. Bank customers are still sitting on a pile of savings manufactured by pandemic-era government stimulus and curtailed consumption. Bank bosses have been warning for two years that this would eventually wither away. To put it in context, if deposits at domestically-licensed banks had grown at their steady, pre-Covid rate over the past three years, they'd total $13.5 trillion today, compared with the latest count of $16 trillion. Among all banks, deposit balances have fallen 5% year-on-year; to get back to their pre-Covid trend, they'd need to fall 20%.

More troublesome than the level of deposits is the cost of those that stay, which is also rising. Bank executives often say that once interest rates hit 3%, depositors start shopping around. Treasury bonds with a 10-year maturity have consistently given yields above that threshold since autumn. Depositors will either chase these higher rates by switching into investment funds, which might be held by a rival bank, or leave them in the same institution but migrate into accounts that lock up funds for longer but at a higher rate. Either has the same effect on the bank: Its funding costs increase, and that puts pressure on its net interest margin.

There too, giant lenders have some weapons at their disposal. Customers, inert at the best of times, are likely to trade some potential interest for knowing their bank is too big to fail, as the top lenders definitely are. That's especially the case while SVB's collapse is still in the headlines, and lenders who wobbled, like First Republic Bank (FRC.N), have yet to show evidence of having durably stabilized. Big banks can also offer customers non-cash perks. JPMorgan invests $14 billion a year on its tech, and has bought dozens of companies to burnish its offering, from restaurant guide The Infatuation to high-end travel agent Frosch. Bank of America touts its artificial-intelligence-powered financial assistant, Erica.

What of small banks that can't match either advantage? The reality is that, for the those at the bottom of the banking pyramid, life is still pretty good. Deposits tend not to flee from the littlest lenders as easily as at their more impersonal mid-sized regional rivals. Better placed within communities to soothe the nerves of mostly local customers, small banks can instill trust and loyalty while allaying fears. Many simply have a geographical advantage, with fewer competitors and less tech-savvy customers. While it's commonplace to hear lobbying groups and politicians fret about the threats to the thousands of American community banks, their finances are strong. Lenders with between $300 million and $3 billion of assets made a return on equity of 14% in 2022, compared with roughly 12% for lenders with over $10 billion, according to quarterly call report filings made to the Federal Deposit Insurance Corp.

This edge for small banks should also insulate them from the worst effects of a deposit price war. They have only passed on 23% of the last year's Federal Reserve interest rate hikes to their customers, according to Darling Consulting, which tracks deposit data for community banks and mid-sized regional lenders. That compares with the roughly 30% that much larger PNC Financial Services reported at the end of 2022. Moreover, small banks are also less exposed to onerous regulation resulting from the collapse of SVB, which is likely to focus on lenders with balance sheets bigger than $100 billion. Not every Congressional representative has a mega-bank in their district, but virtually all have a community bank. True, if these lenders really do fail, regulators will let them - but in the meantime they will be afforded relative freedom.

That leaves the most uncertainty for banks in the middle. There are plenty of them - Silicon Valley Bank and Signature Bank sat in a cohort of roughly 120 lenders with assets between $10 billion and $250 billion. The likes of M&T Bank, KeyBank, Citizens Bank and Western Alliance, are too small to be failure-proof, and too big to command the love and loyalty of customers that community banks claim. Many of them, particularly the 20 or so banks above $100 billion, are bound to face tougher scrutiny over how they manage their liquidity, as well as higher fees to fund future FDIC depositor bailouts. While it's still a wonderful life for the biggest and smallest, it's going to be more of a hard-knock existence for the rest.

JPMorgan, Citigroup and Wells Fargo are due to report first-quarter earnings on April 14. Bank of America is due to follow on April 18.

Analysts polled by Refinitiv estimate that JPMorgan, Wells Fargo and Bank of America will have lost a combined $532 billion in deposits at the end of March, compared with a year earlier.