It was roughly this same time a year ago when the banking industry in the U.S. was going through a series of serious events. Within the space of a few weeks during March through May last year, three of the five largest bank failures in U.S. history occurred. At the outset, a wider banking crisis was feared, but the Treasury Department, the Federal Reserve, and the FDIC acted forcefully, in effect backstopping all deposits, and the three bank failures did not lead to a systemic event. But while the immediate crisis was averted, many of the underlying problems – interest rate pressure, stress in the commercial real estate sector – continue, and now, a year later, the banking industry remains under stress. Problems have continued to emerge, and signs are that challenges in the industry will continue.

Recent evidence points to continuing stress; as I noted in a prior post, in February 2024, the New York Community Bank Corporation was hit with a securities class action after the bank announced steep increases in its loss reserves in their commercial real estate portfolios.

More recently, on April 26, 2024, banking regulators, in what was the first bank failure of 2024, closed Republic First Bank, a $6 billion asset bank based in Philadelphia. Although there were a number of institution- specific factors that contributed to this closure, the company’s commercial real estate portfolio was also under stress and contributed to the bank’s woes. (There was an interesting article in the Journal over the weekend about the bank’s former CEO, here.)

The Republic First failure is the largest bank failure since the three large banks failed last Spring. The immediate question to be asked is whether the bank’s closure points to the possibility of other bank failures ahead.

Signs are that continued stress in the commercial real estate (CRE) sector weighs on many banks, particularly smaller and regional banks. Changing office space use patterns and the rise of hybrid work following the pandemic have changed office space tenants’ needs, putting pressure on landlords and building owners. Landlords are in many instances having trouble servicing their debt, while at the same time building property values are declining.

In a May 1, 2024, article entitled “Office-Loan Defaults Near Historic Levels With Billions on the Line” (here), the Wall Street Journal reported that CRE loan defaults are reaching historic levels “as a growing number of owners capitulate to persistently high interest rates and weak demand.” The article says that more than $38 billion of U.S. office buildings are “threatened by defaults, foreclosures, or other forms of distress.” The loans on many properties, originated when interest rates were at record lows, are maturing at a time when interest rates are much higher while at the same time rent revenues are declining and office vacancy rates are at record levels. The Journal also reports that a number of regional banks have been reporting high net charge-offs due to commercial property exposure. In real estate markets across the country, commercial properties are changing hands at a fraction of their prior sales prices.

At the same time, persistently high interest rates are also continuing to weigh on banks. As the Wall Street Journal reported on April 24, 2024, in an article entitled “Main Street Banking Model is Being Squeezed” (here), pressure from higher interest rates are forcing banks to pay more for deposits, undercutting banks’ profitability. Signs are that relief on the interest rate front may be delayed, as well.

So, given the stresses banks are facing, will there be more bank failures ahead? Time will of course tell, but my operating assumption is that we will see more bank failures in the coming months. One reason I think this is that the Federal Reserve Chair Jerome Powell has told us there will be bank failures ahead.

As discussed here, in a March 7, 2024, presentation to the Senate Banking Committee, Powell said that interest rate pressures and CRE difficulties there will be bank failures ahead. The office space situation, Powell said, “Is a problem we’ll be working on for years more, I’m sure,” adding that “There will be bank failures.” The Fed’s current higher-for-longer interest rate policy could reinforce these possibilities.

Along with the possibilities for further bank failures, I think we will also see further bank-related corporate and securities litigation, along the lines of the securities class action lawsuit filed against NYCB in February. To be sure, I don’t think that in 2024 we will see the same level of bank-related litigation as in 2023; according to my analysis, there were twelve federal court securities class action lawsuits filed in 2023 against companies in the 602 SIC Code Industry Group (Commercial Banks). However, even if there is not the same level of litigation in 2024 as there was in 2023, I do think there will be further corporate and securities lawsuits this year against companies in the banking sector.