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Is a Regional Bank-Led Financial Crisis Imminent? ETFs in Focus

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After the collapse of Silicon Valley Bank and Signature Bank, First Republic Bank (FRBA - Free Report) was one of the hardest-hit regional U.S. lenders during the banking sector's confidence crisis in March. The crisis, witnessed a wave of departure of depositors from smaller banks to industry giants like JPMorgan (JPM - Free Report) .

Per Reuters, after disclosing in late April that the bank had witnessed outflow of $100 billion in the first quarter and a plan to explore alternative options, First Republic saw investors rushing to exit once again. As a result, California regulators seized the bank, initiating FDIC receivership and asset sale.

First Republic's failure marks the third regional bank failure in two months, the largest since Washington Mutual in 2008. The regulators sold the assets of the distressed bank to JP Morgan Chase & Co., in a deal that will see the biggest bank in the United States. pay $10.6 billion to the Federal Deposit Insurance Corp (FDIC). JP Morgan will take over most of the bank’s assets and its coveted wealthy clientele.

Why Did First Republic Fail?

According to a Reuters article, the business model of First Republic, focused on enticing high net-worth individuals with attractive mortgage rates. First Republic's strong financial performance boasted a 19.5% annual compounded shareholder return, outperforming peers. Their borrowers had significant cash access, averaging $685,000. However, their vulnerability stemmed from limited deposit insurance coverage of $250,000 and challenges posed by rising interest rates.

First Republic faced challenges due to substantial uninsured deposits. Moreover, as the Federal Reserve raised interest rates, their loan book and investment portfolio lost value, hindering their ability to raise capital. The bank incurred paper losses when it attempted to outpace competitors on pricing while the Federal Reserve rapidly increased interest rates to combat inflation.

Is PacWest Bancorp Another Bank to Follow Suit?

The fall of First Republic raised concerns among investors for the fiscal well-being of other mid-sized banks, resulting in a fall in shares of other U.S. regional banks like PacWest Bancorp (PACW - Free Report) and Western Alliance Bank (WAL - Free Report) .

PacWest announced that it is exploring strategic options after its shares, along with those of other US regional banks, dropped significantly. Per an article on Reuters, shares of the Los-Angeles bank plunged 52% after its announcement last Wednesday, highlighting the lingering doubts about the health of regional banks, despite regulators' efforts to calm the situation. The PacWest stock has lost nearly 90% of its value since the crisis began with the collapse of Silicon Valley Bank and Signature Bank in March.

Shares of First Horizon Corp (FHN - Free Report) plummeted nearly 40% after Canada-based Toronto-Dominion Bank Group canceled its $13.4 billion takeover last Thursday, intensifying already fragile sentiment surrounding U.S. regional banks and deepening concerns among investors.

Is Financial Crisis Imminent?

U.S. Federal Reserve Chair Jerome Powell reaffirmed the resilience of the banking system despite pressures in March. Powell noted that bank deposits had stabilized. However, there is increasing pressure on U.S. regulators to implement further measures to strengthen the banking sector.

According to CNBC, although shares of the regional banks rebounded last Friday, the recovery was not enough to cover the losses triggered after the collapse of First Republic.

PacWest shares soared almost 82%, while Western Alliance experienced a 49% gain. Nonetheless, despite Friday's rally, the losses incurred earlier in the week remained significant. PacWest ended the week down 43%, falling below its Wednesday’s closing level, with Western Alliance still down 27%.

ETFs in Focus

Against this backdrop, investors should watch regional bank stocks and ETFs closely. Below, we highlight a few ETFs with exposure to the regional banks.

SPDR S&P Regional Banking ETF (KRE - Free Report)

The fund seeks to closely match the performance of the S&P Regional Banks Select Industry Index, which represents the regional banks segment of the S&P Total Market Index. KRE has 143 securities in its basket, with an asset base of $2.82 billion. It charges an annual fee of 0.35% and has a traded daily average volume of about 34.87 million shares.

The fund has a Zacks ETF Rank #4 (Sell) and a High risk outlook. The SPDR S&P Regional Banking ETF was down 10%, despite gaining 6% on the closing day of the week.

iShares U.S. Regional Banks ETF (IAT - Free Report)

The fund seeks to track the investment results of an index composed of U.S. equities in the regional banks space. IAT holds 34 securities in its basket with a 59.46% allocation to regional banks. Having gathered $664.09 million in its asset base, it charges 0.39% as annual fees. IAT has a traded daily average volume of about 1.12 million shares.

IAT has a Zacks ETF Rank #4 (Sell) with a High risk outlook. It fell 7.21% last week and has lost 33.32% year to date.

Invesco KBW Regional Banking ETF (KBWR - Free Report)

The fund is based on the KBW Nasdaq Regional Banking Index, which comprises securities of 50 mid-cap banking companies that are publicly listed in the United States. With a basket of 51 securities, the fund has amassed an asset base of $55.79 million. KBWR charges an annual fee of 0.35% and has a traded daily average volume of about 38,000 shares.

The fund has a Zacks ETF Rank #4 (Sell) and a High risk outlook. It lost 5.42% last week and is down 27.19% year to date.

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