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By now, we all know that the U.S. economy went through a crisis triggered by its regional banking sector in the March-April period. The collapse of three U.S. regional banks since March raised fears of a volley of bank failures. The fragility of the banking system also highlighted concerns about regulatory oversight and systemic risk, and regulators must ensure effective risk management to mitigate these risks.
However, as the chaos settled down, regional bank stocks bounced back with an immense force, due to easing banking volatility and investors’ considerably high risk-on sentiment. These stocks are now trading at a six-week high. Expectations of a less-hawkish policy from the Fed amid a slowdown in inflation also increased the attractiveness of regional bank ETFs.
The ETFs including iShares U.S. Regional Banks ETF (IAT - Free Report) , Invesco KBW Regional Banking ETF (KBWR - Free Report) and SPDR S&P Regional Banking ETF (KRE - Free Report) added in the range of 8% to 11% last week. The segment is ultra-cheap with these three ETFs having P/E ratios in the range of 7.03X to 10.82X.
A Value Trap in the Making?
The seemingly attractive P/E ratios of regional banks might deceive investors into believing it is a value play. But in reality, it is likely to be a value trap. We’ll tell you why.
Fed Policy Tightening Is Yet to Over: Regional banks face intense pressure from depositors and investors due to ongoing rate hikes by the Federal Reserve. Their insufficient equity bases leave them vulnerable to significant losses on security holdings. Reduced deposits and increased funding costs are already impacting profitability, making regional banks susceptible to bank runs and threatening the stability of the entire banking system. With the Fed yet to decide on pausing its tightening policy, more bank runs are likely, at least partially.
Credit Crunch in the Cards: The persistent banking stress is likely to result in a credit crunch, adding to the risks faced by regional banks. Lenders have already tightened their lending standards, reducing credit availability. This credit tightening has an immediate impact on small businesses and low-income households that heavily rely on regional banks for credit.
Struggling Commercial Real Estate: Regional banks play a crucial role in providing credit to small businesses and the commercial real estate (CRE) sector. They are the main source of financing for office buildings, shopping malls, apartment buildings, and related businesses, which are already struggling due to rising interest rates and the COVID-19 pandemic. However, the combination of rising interest rates and the impact of the COVID-19 pandemic has left CRE exposed.
The commercial real estate market is already grappling with decreasing office values and a looming repayment deadline of nearly $1.5 trillion in property debt by the end of 2025. This situation has made many properties less valuable, putting regional banks at risk due to their substantial exposure to the commercial real estate sector.
Monsur Hussain, head of research for global financial institutions at Fitch Ratings, said that regional banks have approximately14% of their total assets in CRE exposures, but it can be as high as over 40% of their total assets, as quoted on Bloomberg.
Lesser Regulatory Scrutiny? The vulnerability of US banks to a decline in commercial real estate prices has increased substantially. A significant number of banks—700 in total—now surpass the Federal Deposit Insurance Corp.'s guidance on commercial real estate loan concentration (per Torsten Slok, chief economist at Apollo Global Management Inc, quoted on Bloomberg), a number that has doubled in just two years. This situation leaves regional banks and the entire banking system exposed to potential shocks, as regulatory scrutiny is relatively lax.
Is There Any Way Out?
The future hinges on the Federal Reserve's actions. A less hawkish Fed could fuel a rally in regional banking ETFs and stimulate investment in growth sectors like technology. Real estate and homebuilding sectors could flourish in a low-rate environment and benefit regional banks. JPMorgan CEO Jamie Dimon suggests the banking crisis has passed, but challenges remain.
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Regional Bank ETFs: Value Play or Value Trap?
By now, we all know that the U.S. economy went through a crisis triggered by its regional banking sector in the March-April period. The collapse of three U.S. regional banks since March raised fears of a volley of bank failures. The fragility of the banking system also highlighted concerns about regulatory oversight and systemic risk, and regulators must ensure effective risk management to mitigate these risks.
However, as the chaos settled down, regional bank stocks bounced back with an immense force, due to easing banking volatility and investors’ considerably high risk-on sentiment. These stocks are now trading at a six-week high. Expectations of a less-hawkish policy from the Fed amid a slowdown in inflation also increased the attractiveness of regional bank ETFs.
The ETFs including iShares U.S. Regional Banks ETF (IAT - Free Report) , Invesco KBW Regional Banking ETF (KBWR - Free Report) and SPDR S&P Regional Banking ETF (KRE - Free Report) added in the range of 8% to 11% last week. The segment is ultra-cheap with these three ETFs having P/E ratios in the range of 7.03X to 10.82X.
A Value Trap in the Making?
The seemingly attractive P/E ratios of regional banks might deceive investors into believing it is a value play. But in reality, it is likely to be a value trap. We’ll tell you why.
Fed Policy Tightening Is Yet to Over: Regional banks face intense pressure from depositors and investors due to ongoing rate hikes by the Federal Reserve. Their insufficient equity bases leave them vulnerable to significant losses on security holdings. Reduced deposits and increased funding costs are already impacting profitability, making regional banks susceptible to bank runs and threatening the stability of the entire banking system. With the Fed yet to decide on pausing its tightening policy, more bank runs are likely, at least partially.
Credit Crunch in the Cards: The persistent banking stress is likely to result in a credit crunch, adding to the risks faced by regional banks. Lenders have already tightened their lending standards, reducing credit availability. This credit tightening has an immediate impact on small businesses and low-income households that heavily rely on regional banks for credit.
Struggling Commercial Real Estate: Regional banks play a crucial role in providing credit to small businesses and the commercial real estate (CRE) sector. They are the main source of financing for office buildings, shopping malls, apartment buildings, and related businesses, which are already struggling due to rising interest rates and the COVID-19 pandemic. However, the combination of rising interest rates and the impact of the COVID-19 pandemic has left CRE exposed.
The commercial real estate market is already grappling with decreasing office values and a looming repayment deadline of nearly $1.5 trillion in property debt by the end of 2025. This situation has made many properties less valuable, putting regional banks at risk due to their substantial exposure to the commercial real estate sector.
Monsur Hussain, head of research for global financial institutions at Fitch Ratings, said that regional banks have approximately14% of their total assets in CRE exposures, but it can be as high as over 40% of their total assets, as quoted on Bloomberg.
Lesser Regulatory Scrutiny? The vulnerability of US banks to a decline in commercial real estate prices has increased substantially. A significant number of banks—700 in total—now surpass the Federal Deposit Insurance Corp.'s guidance on commercial real estate loan concentration (per Torsten Slok, chief economist at Apollo Global Management Inc, quoted on Bloomberg), a number that has doubled in just two years. This situation leaves regional banks and the entire banking system exposed to potential shocks, as regulatory scrutiny is relatively lax.
Is There Any Way Out?
The future hinges on the Federal Reserve's actions. A less hawkish Fed could fuel a rally in regional banking ETFs and stimulate investment in growth sectors like technology. Real estate and homebuilding sectors could flourish in a low-rate environment and benefit regional banks. JPMorgan CEO Jamie Dimon suggests the banking crisis has passed, but challenges remain.