Regional Banks Shrink Balance Sheets as Stricter Rules Loom

US regional banks are shrinking their balance sheets to strengthen capital and improve liquidity as heightened interest rates and an anticipated tightening of regulations loom over the sector.

(Bloomberg) — US regional banks are shrinking their balance sheets to strengthen capital and improve liquidity as heightened interest rates and an anticipated tightening of regulations loom over the sector.

U.S. Bancorp said it increased its CET1 capital ratio in the second quarter by 60 basis points from the previous three months while also making targeted asset sales and securitizing auto loans in an effort to cut risk on its balance sheet. Citizens Financial Group Inc. earmarked around $14 billion in loans that it will allow to run off its balance sheet as part of “intensified balance sheet optimization efforts.”

In the most dramatic example so far this quarter, Western Alliance Bancorp said it sold roughly $4 billion in assets, including $3.5 billion in loans tied to residential, commercial real estate and business lending, to improve capital and liquidity while reducing wholesale borrowing.

Lenders are taking the steps after the most aggressive rate hikes by the Federal Reserve in decades eroded the value of assets held on their balance sheets while driving deposits out of bank accounts and into higher-yielding alternatives such as Treasuries. Those trends contributed to a series of regional bank failures earlier this year that shook the sector.

“It’s all about improving liquidity and capital ahead of tougher regulations. It’s also about improving the balance sheet to make it more profitable because of the higher funding costs,” said Herman Chan, a Bloomberg Intelligence analyst. “It creates a higher bar in terms of creating profitable growth. That’s why you’ve seen banks like Citizens pull back in areas that are less profitable for them.”

Shares of U.S. Bancorp, Citizens and other regional banks all climbed Wednesday morning, with the KBW Bank Index up 2.6% at 12:22 p.m. in New York.

Among banks reporting results Wednesday, U.S. Bancorp, Citizens and M&T Bank Corp. all said average deposits fell from the prior quarter as depositors spend money from their accounts or move their funds into higher-yielding alternatives. Financial firms are being forced to pay more for the deposits that stick around, cutting into the benefit to lending profits created by higher interest rates.

Average deposits at Minneapolis-based U.S. Bancorp, the country’s largest regional bank by assets, slipped 2.6% from the first quarter to $497.3 billion, missing the $503.2 billion average of analysts’ estimates in a Bloomberg survey. Noninterest-bearing deposits dropped even more dramatically, slumping 12%, according to a statement Wednesday. End-of-period deposits increased 3.2% from the first quarter to $521.6 billion.

At Buffalo, New York-based M&T, average deposits totaled $159.4 billion. While that just beat analysts’ estimates, it was down 9% from a year earlier and 1% from the second quarter, with the bank citing a shift to higher-cost deposits and competition. The bank said it expects $7 billion to $7.2 billion of net interest income this year, which was “trending toward the low end of the range.”

NII Declines

Citizens, meanwhile said its net interest income fell 5.5% from a year earlier. Average deposits dipped almost 1% from the first quarter to $173.2 billion. The Providence, Rhode Island-based bank saw its total interest expense jump to $943 million as the cost of deposits and short- and long-term funding also jumped. The bank expects net interest income for 2023 to fall 4%. 

“This was a really important quarter for us to get the deposit level where we wanted, to get the Federal Home Loan Bank borrowings lower,” Citizens Chief Executive Officer Bruce Van Saun said on a conference call with analysts. “At this point, we feel that we don’t need to really aggressively grow deposits. We can have a more stable deposit profile.”

Even before it became clear US regulators planned to implement more stringent capital requirements for lenders, U.S. Bancorp’s acquisition of MUFG Union Bank meant it faced a move into a supervisory category that would require the bank to factor unrealized losses into its capital levels.

U.S. Bancorp has been adamant that existing efforts would preempt any need for a further capital raise. Executives said on a conference call with analysts that they’re confident they’ll be able to reduce risk-weighted assets to hit the bank’s targets.

“The reaction in the market today, it’s all around capital,” Chief Financial Officer Terry Dolan said in a phone interview. He said the rate at which the bank accrued capital and the CET1 ratio achieved demonstrate it will be able to shift categories and handle tougher regulations. “That is an important milestone.”

(Updates with CFO comments in last paragraph.)

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