By Greg Jensen
Regional banks have been frustrating for investors since the financial crisis. They were a sexy pick by many to lead the recovery. Everything looked to be in place; those that had survived should be the fittest, real estate was bound to recover, economic recovery was about to generate huge demand for loans. It was a no brainer.
The chart for KRE, the SPDR S&P Regional Banking ETF, tells the story. For the first couple of years of the recovery, it was a bumpy ride. Stubbornly high unemployment, a de-leveraging consumer, Dodd-Frank, the dragged out mess with mortgages; all these and more kept the recovery in regional banks muted. Since the beginning of last year, however, the clouds have started to clear. Dodd-Frank proved to be a minor inconvenience, not the bank-killer many claimed it would be. Eventually the mortgage mess began to sort itself out and unemployment, while still high, is falling gradually. Regional banks have rallied strongly.
As a result, KRE, and many of the individual regional banks, are at or near multi-year highs. I hate to be the party pooper here, but it seems to me that there is one part of the story missing; you and me, the consumer. Church halls around the country are still packed one night a week for Dave Ramsey classes. The message, that we should concentrate on being debt free and give our excess income to charity, rather than to the bank, is a powerful one. Many people remember that sick feeling when businesses were closing and jobs were being lost in 2009 only too well. “How will we survive?” wasn’t the question; it was “how will we keep up the payments?” They are determined not to get in that position again.
Small and mid-sized regional banks are heavily reliant on consumer loans, a well that is drying up. Many have responded by building their bond portfolios, as detailed in this article on Reuters. Given the current level of interest rates, I see little room for any serious appreciation in those portfolios, and should the bond market return to historic norms, the possibility of significant losses.
Regional banks have also been hobbled by what they are. By definition, the ones that survived the financial crisis were fairly conservative in their lending policies. They, along with everybody else, tightened lending standards post-recession, but started from a conservative position.
So we have a situation where both demand and supply for loans is being restricted, leaving the banks sitting on cash that is earning little interest, invested in bonds with some downside risk. The big boys have wealth management and brokerage services to fall back on, but the small and mid-sized banks are getting squeezed. The optimism coming from improvements in some sectors looks a little misplaced. A correction looks due.
If you own the likes of BB&T(BBT), SunTrust (STI), Region Financial (RF) or First Horizon (FHN), a little insurance in the form of protective puts or selling covered calls may be prudent. If you have avoided the sector until now, I believe there will be a pullback before too long, so I wouldn’t go jumping in just yet.