Financial services exchange traded funds delivered some big disappointments in March and regional bank ETFs were particularly egregious offenders. For example, the iShares U.S. Regional Banks ETF (NYSEArca: IAT) slumped more than 7% last month.
Predictably, much of the bull case for regional banks depends on the Federal Reserve and interest rates. With a steepening yield curve or wider spread between short- and long-term Treasuries, banks could experience improved net interest margins or improved profitability as the firms borrow short and lend long. Although the Fed unveiled its first rate hike of 2017 last month, the central bank’s dovish tone punished regional bank stocks and ETFs.
Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector. Regional banks are among the stocks most positively correlated to rising interest rates because higher rates improve net interest margins.
However, some market observers see other catalysts on the horizon and those catalysts are expected to come on the regulatory front.
“These organizations could see potentially significant regulatory relief under the new administration if they are legally differentiated from larger, more complicated bulge bracket banks, which represent the country’s largest multinational investment banks,” said BlackRock in a recent note.
President Donald Trump’s official transition website stated that the “financial Services Policy Implementation team will be working to dismantle the Dodd-Frank Act,” which was signed into law by President Barack Obama in 2010 to obviate another financial downturn. The law increased the burden of banks to safe guard against another meltdown event and forced many to greatly reduce exposure to riskier assets, which have also dragged on the financial sector’s bottom line.
Politics might be the lone remaining catalyst for the sector for a while and that could weigh on regional banks that were hoping for a more hawkish Fed.
The problem with that scenario, as was seen with financial services ETFs last week, is that markets are growing concerned with the Trump Administration’s ability to push through some of the bigger objectives on its legislative agenda, including tax reform and rolling back the Dodd-Frank Act. Those two goals are widely seen as positives for bank stocks.
“Nonetheless, regional banks may stand to gain the most among financials from regulatory easing and a more favorable macroeconomic environment—assuming both occur. Larger banks may still perform strongly in a reflationary environment and may serve as a portfolio diversifier,” according to BlackRock.
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