by Bryan Perry
December 19, 2023
For the past six weeks, the market rally has lifted most sectors out of some very bearish downtrends, the financials being one of them. While there is a base case for wanting to own bank stocks – such as a more constructive outlook for the economy, and lower interest rates – there are some major hurdles facing the regional banks that must be cleared out before this sector can be on long-term sound footing.
I’ve itemized what I believe are areas of current and future stress facing the banking sector, below:
- Regional banks have seen hundreds of billions of dollars in customer deposits flow out of their accounts and into money markets at major brokerage firms, seeking higher yields.
- Regional banks bought hundreds of billions of dollars in low-yielding long-dated Treasuries when the Fed flooded the system with liquidity during the Covid-19 outbreak, resulting in massive unrealized losses on their balance sheets.
- Regional banks still have over $1.5 trillion in commercial real estate loans on the books that are all due to be refinanced between 2024 and 2027.
- Regional banks are currently coping with increased regulatory standards and more stringent lending criteria to businesses and individuals following the spring 2023 banking crisis, when the Fed and FDIC had to intervene with a $500+ billion bailout, guaranteeing all deposits
- Regional banks are now facing a highly inverted yield curve, which impacts Net Interest Margin (NIM), a measurement comparing the net interest income a financial firm generates from credit products like loans and mortgages, with the outgoing interest it pays holders of savings accounts and certificates of deposit (CDs). The Discount Rate (which banks pay the Fed to borrow money) is currently at 5.5%. With lending rates coming down along the yield curve, profits are squeezed.
During 2023, the FDIC reported five large regional bank failures, with total assets of $753.5 billion, each of which had to be resolved by the seizure and sale of assets. They are listed below:
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
To monitor this sector, the KBW Nasdaq Regional Banking Index (KRW) seeks to reflect the performance of U.S. companies that do business as regional banks or thrifts. From the one-year chart, below, it is easy to see how the market euphoria of the past two months has pushed this index right back up to where it first broke down, triggered by the Silicon Valley Bank, Signature Bank and First Republic Bank failures.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The SPDR Regional Banking ETF (KRE) reflects a very similar chart, showing key technical resistance just overhead, where its 200-week moving average (black line) lies, even though the issues hampering the regional banks haven’t improved, other than the perception that conditions will improve in 2024.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It’s hard to argue with the Fed’s recent pivot, which fueled massive short-covering and the notion that consumer and business lending will experience more favorable borrowing terms, but I think the 800-pound gorilla in the room is the commercial real estate refinancing dilemma facing regional banks.
Scores of commercial properties have seen valuations fall by as much as 50% in major cities, amid sky-high vacancy rates. America’s office market is still in a major correction, and office buildings may have another 20% to fall, according to research firm Capital Economics. “Persistent weak growth and elevated (albeit soon-to-be-falling) interest rates continue to spell trouble for real estate values,” the firm said on Friday. “Offices still face a substantial value adjustment, with another 20% fall to come in our view.”
Business Insider (in “America’s office market will plunge another 20% in value next year and will take decades to climb back to its peak”) added, “property owners who are able to refinance their mortgages are having to do so at much higher interest rates. That could bring a wave of distressed debt, some economists warn, as there’s around $1.5 trillion of commercial real estate debt maturing over the next few years.”
Based on how the market has seemingly turned a blind eye to these risks, one could argue that the recent spike in the regional bank sector is a prime set up for a shorting opportunity following a torrid rally in the major averages. I’m not saying to fight the tape or the Fed, but there are some deep-set problems within the regional banks that will likely dampen top- and bottom-line growth going forward. And when the profit-taking shows up – and it will, at some time – there could be fat profits made from downside bets.
Check out the book or movie, “The Big Short” for a dramatic reading about how such bets can pay off.
All content above represents the opinion of Bryan Perry of Navellier & Associates, Inc.
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Income Mail by Bryan Perry
New Bull Market for Regional Banks? Not So Fast
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My 10 Best Books of 2023 (Christmas Gift Ideas)
Global Mail by Ivan Martchev
Fed Chair Jerome Powell Goes Full Circle
Sector Spotlight by Jason Bodner
Long (and Super-Short) Cycles in Nature and in Markets
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Bryan Perry
SENIOR DIRECTOR
Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.
Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. All content of “Income Mail” represents the opinion of Bryan Perry
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