Don’t Bank On It

Don’t Bank On It

With this article, we are introducing a new series we intend on writing for the foreseeable future. For those of you that have been following our public banking articles, you would know that we have been highlighting the major existential issues that are found on many bank balance sheets today.

In this new series of articles entitled “Don’t Bank On It,” we are going to highlight existential issues found on a specific bank’s balance sheet.  But, we are challenging readers to figure out which bank we are highlighting in the specific article.

Our first highlighted bank is a publicly listed U.S. bank with total assets of nearly $20B and operates in 8 states, mostly in the eastern half of the United States. In the most recent reported quarter, the bank generated quarterly revenue in the low-to-mid hundreds of millions and reported positive diluted EPS. Its holding company had a market capitalization around 4 billion at quarter-end. Below, we examine the bank's business model and balance-sheet vulnerabilities as an anonymized case study rather than as an institution-specific profile.

Massive CRE exposure

Based on third-party bank-risk screening data, this bank appears to have unusually high commercial real estate exposure compared with other U.S. banks above the $10B asset threshold. Its CRE exposure is approximately 500% of its total equity, placing the loan book in a category that deserves close attention in a weaker credit cycle.

We have written many times about CRE risks that are likely to pressure the banking sector over the next two to three years. For this bank, however, the issue is not just exposure to CRE in general; it is the scale of the exposure relative to capital. Even a modest loss rate on the CRE portfolio could translate into a meaningful hit to equity before taxes and reserve absorption.

The structure of the CRE book makes the risk more concerning. A significant share of the portfolio is tied to income-producing real estate, where repayment depends on property cash flows, tenant demand, occupancy, rents, refinancing markets and interest rates. In a weaker CRE cycle, these loans can become much more difficult to refinance or repay.

The CRE mix also appears exposed to property categories that remain sensitive to higher rates, weaker transaction activity and lower refinancing availability. The key point is not one single property type, but the bank's broader dependence on real-estate-backed credit performance.

Very fragile funding profile and liquidity risk

The same third-party screening data also points to a liability structure that may be less stable under stress. Approximately two-thirds of the bank's deposits appear to be uninsured, placing it toward the higher-risk end of the large-bank universe on this metric. A deposit base with a large uninsured component can be less stable during periods of stress, especially if credit concerns become more visible.

Liquidity coverage also looks weak relative to this funding profile. The bank's liquid assets cover only a limited portion of uninsured deposits. This means the bank is highly dependent on depositor confidence, market funding access and the availability of contingent liquidity if uninsured depositors begin to leave.

This is the type of funding structure that can become dangerous very quickly. The SVB case showed that a concentrated and uninsured deposit base can turn a balance-sheet concern into a liquidity crisis in a matter of days. Even before considering the asset side of the balance sheet, this liability profile is fragile. Combined with a concentrated CRE book, the overall risk profile becomes more concerning.

It is also worth noting that the deposit base is not especially cheap. A relatively limited share of deposits is non-interest-bearing, which reduces the benefit of low-cost funding and leaves the bank more exposed to deposit pricing pressure.

Finally, the bank's loan-to-deposit ratio is elevated. That leaves limited balance-sheet flexibility, particularly for a bank with high uninsured deposits and a loan book heavily exposed to CRE.

Asset quality is already deteriorating

The credit cycle has not yet become severely stressed, but this bank is already showing signs of asset-quality deterioration. In the latest reported period, non-performing assets increased meaningfully year over year, reflecting stress in real-estate-backed lending.

Provisioning also looks elevated compared with peers. The bank's cost of risk is above selected peer averages, while loan-loss coverage remains modest for this business mix. For a bank with large CRE exposure, this reserve level does not provide much comfort if credit losses accelerate.

The key issue is not that current losses are already catastrophic. The issue is that asset quality is weakening before the sector has experienced a full CRE downturn. If macro conditions deteriorate, refinancing pressure increases or property values fall further, the bank could face a much sharper increase in problem loans.

Capital is light for this business model

The bank's CET1 ratio is below selected peer averages. On a standalone basis, this capital level may not look alarming. But relative to this bank's balance-sheet risk, it looks light.

A bank with CRE exposure several times equity, a high share of uninsured deposits, limited liquid-asset coverage of uninsured deposits and an elevated loan-to-deposit ratio should arguably run with a larger capital buffer. Instead, capital appears less conservative than the risk profile would suggest.

This is the core problem: the bank does not need a disastrous credit cycle to face pressure. Even a moderate deterioration in CRE credit quality, combined with deposit outflows or higher funding costs, could quickly expose the weakness of this balance sheet.

Conclusion

This bank combines several risk factors that are individually concerning and collectively dangerous: excessive CRE exposure, reliance on uninsured deposits, weak liquid-asset coverage, an expensive deposit base, limited balance-sheet flexibility, early asset-quality deterioration and capital that appears light for the business model.

Can you recognize this bank?  If not, you can come to our StockWaves service at ElliottWaveTrader.net to identify it and view not only the fundamentals report but the Elliott Wave analysis to assist in making investing decisions. Here is the link:

https://www.elliottwavetrader.net/trading-room/post/10276742