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Can the Rally in Regional Bank ETFs Continue?

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Regional banking ETFs rallied yesterday as bank worries appeared to ebb.iShares U.S. Regional Banks ETF (IAT - Free Report) andSPDR S&P Regional Banking ETF (KRE - Free Report) added about 6.5% and 5.8% on Mar 21. Financial Times reported that the U.S. Treasury Secretary Janet Yellen hinted at further U.S. government backing for deposits at smaller American banks, should the need be. Yellen said that guarantees offered to all depositors at the failed Silicon Valley Bank could be replicated at other institutions, if required.

By now, we all know that the U.S. economy is going through a crisis triggered by its regional banking sector that started in early March. The failures of Silicon Valley Bank and Signature Bank were the epicenter of the crisis, which hit the entire space hard.

First Republic Bank has also walked the same route as its peers. But large U.S. banks deposited around $30 billion in First Republic Bank last week in a bid to rescue the latter from a widening credit crisis. Though the liquidity injection too failed to shore up investors’ confidence in First Republic Bank initially, regulators’ steadfast efforts arrested the crisis at right time in the whole space.

Can the Rally Last?

It all depends on the Fed’s actions. Investors should note that the run on SVB started on Mar 9, after the bank’s strategic update to investors revealed that it had sold substantially all of its Available for Sale securities portfolio of $21 billion, most of which were U.S. treasury bonds. SVB had locked these treasuries at a yield of 1.79% and had to book a loss of $1.8 billion on this transaction due to a spike in rates past year (read: ETF Strategies to Tide Over the Ongoing Banking Crisis).

The Federal Deposit Insurance Corp’s (FDIC) retaining of those securities would safeguard the acquirers from not booking a loss on them. So, all in all, the higher rates, indirectly, have caused a long-feared crisis in the market and economy. Maybe, smaller banks felt the heat first for holding low-yielding treasury bonds. But the fact is that big banks too have held it.

So, the journey from here is dependent on the Fed moves. If the Fed acts less-hawkish or dovish in the coming days, we can see a rally in regional banking ETFs. A less-hawkish Fed should boost investing in growth sectors like technology. Then, regional banks exposed to the small-cap tech sector or tech start-ups should not face much of the crisis. Not only that, several other sectors like real estate and homebuilding should prosper in a low-rate environment and not pose any threat to the regional banks.

Moreover, a less-hawkish Fed should bolster the risk-on trade sentiments. This, in turn, would increase the long-term bond yields, resulting in a steepening of the yield curve. This scenario is favorable for bank ETFs as it widens the banks’ net interest rate margins.

Any Wall of Worry?

New research co-authored by Columbia Business School's professor of real estate Tomasz Piskorski finds that the banking industry’s unrealized losses are now more than three times that, with the system gathering $2.2 trillion in unrealized losses over the past year, as quoted on Yahoo Finance. These paper losses across the U.S. banking sector indicates that other banks with high levels of uninsured depositors and large losses are also vulnerable to solvency crises that could activate further bank runs.

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