Small banks are struggling just as the world needs them most

Bloomberg

Policy makers trying to prevent credit markets from freezing up have a huge challenge on their hands with regional banks.
Such firms should be best positioned to keep money flowing to community businesses like restaurants, travel agencies and gyms on the brink of failure because of the coronavirus pandemic. But regional banks themselves are increasingly at risk, riven by years of low margins, bad debt and now the threat of ratings cuts.
At smaller lenders from the US to Japan to South Korea, profits had already been pressured by historically low interest rates. The virus adds to their woes, boosting the risk that bad loans will pile up at the smaller businesses they serve.
Four South Korean regional banks were placed on review for downgrade this week by Moody’s Investors Service, which said the pandemic will hurt economic growth as well as banks’ credit quality. In the US, dozens of small banks called on lawmakers to delay major loan-loss accounting rules they say will force them to curtail lending.
Regionals are more exposed to “the plain old squeezing of the margin between where banks borrow and where banks lend,” Wells Fargo & Co. analyst Mike Mayo said in an interview. “As a group they’re more exposed” to the Federal Reserve’s recent rate cuts, he said.
Rate cuts worldwide have crimped banks’ net interest margins, the difference between what they earn from loans and pay for deposits, as well as interest income abroad. Analysts say that the virus could cause bad loans to jump in China, while more regional lenders in Japan may start to post losses if the central bank there cuts rates further.
“Rising loan losses would be a chief concern with the virus slowing economic activity globally,” said Bloomberg Intelligence analyst Herman Chan. “The outlook for US regional banks is challenging with loan losses set to rise and revenues weakening after the Federal Reserve rate cuts.”
The KBW Regional Banking Index of 50 US lenders has tumbled more than 40% this year, with those exposed to energy particularly hard hit as virus fears sap demand. Shares of Houston-based Cadence BanCorp, the worst performer in the group, have plunged almost 70%.
The $2 trillion stimulus bill in the US carves out more than $350 billion in aid for small businesses, much of which would be in loans through the Small Business Administration and banks, guaranteed by the federal government.
Investors are hungry for details about how the economic impact of the pandemic will hit firms’ geographies and industry concentrations.
“What’s unique is that it’s not one concentration that’s an issue, this is going to affect a lot of different types of industries that they lend to,” KBW analyst Brian Klock said in an interview. “They’re Main Street lenders, and that’s where it’s going.”
In South Korea, the asset quality of Busan Bank, Daegu Bank, Jeju Bank and Kyongnam Bank could deteriorate, Moody’s said. That’s because they have concentrated exposures to the region’s worst-hit by the virus, namely Daegu and North Gyeongsang province, and highly affected sectors such as small- and medium-size enterprises in the tourism, services, food and beverage, and retail sectors.
In China, the virus may cause the nation’s non-performing loan ratio to more than triple to about 6.3%, amounting to an increase of 5.6 trillion yuan ($787 billion) in bad debt, according to S&P Global Ratings. A deterioration in banks’ asset quality and profitability are raising concerns that more regional lenders will come under pressure after at least three banks were rescued last year.
“We have no doubt there will be more,” said Logan Wright, a Hong Kong-based director at research firm Rhodium Group LLC. “What we are waiting for is a kind of a road map or a path to how these restructuring will take place in the future.”