How PNC, Citizens & Other Regionals Are Prepping for the Future Beyond CRE

Regional players will be focused on the commercial real estate cleanup for a while. But some are already looking beyond the issue, asking what they have to do to face down intensifying competition from the megabanks.

Regional banks face multiple challenges in the present, including commercial real estate issues. But what of the long term? How should they evolve their business models?

During his organization’s first quarter 2024 earnings briefing, Tim Spence, chairman, CEO and president at Fifth Third Bancorp, was asked by Morgan Guaranty analyst Manan Gosalia how he saw his institution and other regionals changing in the near future.

Spence had broached the issue in his 2023 annual report letter, writing that rising capital requirements are going to make banks take a hard look at some activities. An example: Spence is convinced that regional and community banks will be exiting businesses in which they can’t profitably compete without more client support. He cited Fifth Third’s own “risk-weighted asset diet”: In 2023, the bank looked at several areas where they weren’t picking up enough business to make the game worth the costs under current regulatory conditions. One example was making loans to large public companies, which was formerly considered profitable enough.

“We walked away from companies where we were an important lender, but we weren’t getting a fair share of the ancillary services they needed because those were being provided by the money-center banks.”

— Tim Spence, Fifth Third Bancorp

This didn’t happen overnight. Once the thin users had been identified, Fifth Third bankers put it to them: We can’t keep being one of your lenders if we can’t serve your other business needs, too.

One out of four corporate customers shrugged, but three out of four asked the bank to work with them to create a broader relationship. Spence said that the corporations moved a “significant” amount of ancillary business to Fifth Third.

Regional banks’ operating norms must also be examined for potential change, according to Spence — particularly labor productivity. So far, branch rationalizations have helped, but he’s looking to technology — cloud computing, artificial intelligence, and other leading-edge tools — to bring the next wave.

“It’s hard to imagine that there are going to be 4,000 banks in the future,” said Spence. “Whether it’s 1,000, 2,000 or 3,000 banks, you’re going to see some consolidation.”

Fifth Third’s Strategic Move to the Southeast and Texas

Spence also predicted that banks that had made forays into new markets will have to make good — or fall back. He said they will “be retreating to places where they have density, focusing on markets where they can neutralize the scale advantages the large banks have because they are the same size in the area where you compete.”

Fifth Third itself has been pursuing new geographic markets. Since 2018 it has opened 100 de novo branches in the Southeast, to take advantage of regional growth higher than the national rate. Spence says the company’s goal is to become one of the top five banking institutions in each Southeastern market it enters, to support a primary-bank model.

In the near-term, he said, the Southeast expansion helped bring in sufficient deposits that the bank didn’t have to pay up as much overall for deposits than if it had not expanded its territory. In addition, on the business banking front, Fifth Third also pressed further into the Texas market to serve the energy business. Both efforts have brought the bank benefits, on top of strong middle-market loan growth from federal incentive investments in manufacturing and energy infrastructure.

Read more: Credit Cards Fuel Big Banks’ Loan Growth Amid ‘Normalization’

A Key Business Model Feature: Acquiring to Build Scale

Meanwhile, William Demchak, chairman, president and CEO at PNC, is urging federal regulators to permit more mergers in order to empower regional and smaller banks to counteract the organic growth powering the largest U.S. banking organizations.

In a long letter addressing proposals to change the M&A policies of the Office of the Comptroller of the Currency, Demchak said that the proposed revisions “would only serve to further accelerate the unhealthy consolidation at the very top of the banking industry by allowing the biggest banking organizations to continue to grow unchecked.” He noted that JPMorgan Chase and Bank of America together had grown their national retail deposit market share by more than 400 basis points, together, since 2013. (Demchak acknowledged that PNC had benefited from the trends that led to this growth, but said that the biggest banks had benefited more.)

An analyst pressed Demchak for more on the matter and his prediction as to whether M&A activity would be eased in the run-up to the election.

“The banking industry by and large is set up to do well over the next 18 months or so simply through rates normalizing, assuming you didn’t have big concentrations in [office commercial real estate],” said Demchak. “I think everybody in the near term is focused on that.

Demchak said he was more worried about the period after those 18 months are over.

Read more: The Great M&A Debate: Regional Bankers Argue the Need to Buy Scale in 2024

Strategic and Geographic Moves Underway to Boost Regionals’ Potential

At Citizens Financial Group, officials spoke of the success of several recent initiatives. One is its move into the New York branch market. Bruce Van Saun, chairman and CEO, said the new thrust was producing the fastest growth among all of the company’s retail banking regions. This foray contributed to Citizens’ year-over-year growth in retail deposits of 20%, he said. Van Saun said the company’s push into private banking was also going well, passing $2.4 billion in deposits at the end of the first quarter.

Private banking has also produced growth in commercial credit, which Van Saun expects to contribute to overall business loan growth in the second half. Some longstanding strategies, such as the bank’s leading home equity line of credit program, are continuing to produce.

At Huntington Bancshares, several new business specialty vertical groups have been launched. Earlier this year, for example, Huntington put together a team to handling commercial and investment banking services for Native Americans. This includes government, gaming, hospitality, infrastructure and economic development needs. Several of the leaders initially hired are themselves members of Native American tribal groups or bands.

Recent geographic expansions into North and South Carolina and Texas are showing some promise, according to Stephen Steinour, Huntington chairman, president and CEO.

But some interesting moves are not contemplated at present.

While Fifth Third’s move into Texas, for example, has been paying off on the commercial side, moving on the retail banking front would be a formidable challenge.

“I wouldn’t rule that out,” said Fifth Third’s Tim Spence, “but those [Texas markets] are very large markets that we’re talking about here. They’re not markets of between 0.5 million and 3 million people, which has been the expansion strategy in the Southeast. So, any effort [would require] 50-100 branches in a single city in many cases, as opposed to what we’re doing in the Southeast right now, which is building 10-25 branches at the individual market level.” [Emphasis added.]

Read more: Neobank ‘Totem’ to Serve Native Americans with Unique Revenue Model

How Regionals Say They Are Handling Commercial Real Estate Challenges

The regionals’ discussions about commercial real estate lending issues, especially CRE office credit, has undergone a change in tone since the fourth quarter. Then, they reassured markets by saying they were getting on top of CRE issues, especially in the office area, and acting aggressively. This time around, leaders portrayed CRE as an ongoing but containable challenge, one that their organizations are working through with basic blocking and tackling and lots of consultation with borrowers.

“We posted another quarter of zero net charge offs in CRE and have less than $3 million of nonperforming assets in our non-owner-occupied portfolio,” said Fifth Third’s Tim Spence.

Some officials minimized their banks’ holdings of CRE, especially office credit. In a related vein, Huntington’s Steinour pointed out that his bank trimmed the CRE office portfolio by $500 million over the previous four quarters.

Don McCree, head of commercial banking at Citizens, said the bank has reduced total office CRE from $4.2 billion to $3.4 billion. “It’s actually coming down nicely and the charge-offs have actually been modest.”

“The pig is going through the python,” said Citizens Van Saun. “It’s going to take a few more quarters for that to fully work its way through.”

“The office portfolio remains an area of focus, but we are adequately reserved overall, and particularly with respect to CRE,” said PNC’s Demchak. “We believe our thoughtful approach to managing risk, customer selection, and long-term relationship development will continue to serve us well.” Demchak pointed out that while office CRE nonperforming loans have been increasing over recent quarters, the level of criticized loans has remained “relatively consistent.”

“It really comes down to the building and the market. You could have a building that’s in the right place in Pittsburgh and it’s doing absolutely fine, and you could have a building that’s in the wrong place in Pittsburgh and it’s literally worth zero.”

— William Demchak, PNC Financial Group

Demchak added that most types of real estate credit currently has steady cash flow. “The problem you have in office is that in many instances there’s no cash flow at all,” he said. “It’s a really unique animal at the moment.”

“On the CRE front, we saw really good performance this quarter,” said Daryl Bible, senior executive vice president and CFO at M&T Bank Corp., admitting that “one quarter doesn’t make a trend yet, but it was a positive quarter.” Bible said that some categories of loans had lower levels of criticized credits than the previous quarter, though health care and office CRE levels of criticized loans were up slightly. Bible also noted that the bank has been cranking down the share of its lending that CRE represents and has continued to make progress on that goal.

Bank of America analyst Ebrahim Poonawala asked how much more stress M&T’s CRE portfolio would undergo if there were no interest rate cuts over the next two years. Bible minimized the impact of that possibility. He said that most of the CRE portfolio consisted of loans that either carried fixed rates or that effectively had fixed rates as the result of use of interest-rate swaps. Taking all that into account, he said, only 29% of the portfolio floats.

Overall, Bible described a lot of hand-holding with CRE borrowers. In many cases, the bank has been asking for, and receiving, additional equity in deals in order to better cover risk to the bank. In exchange, Bible said, the bank typically gives them extensions of anywhere from six months to year on top of the original term.

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