Even with the benefit of three interest rate increases by the Federal Reserve, regional bank stocks and exchange traded funds are struggling this year. The iShares U.S. Regional Banks ETF (NYSEArca: IAT), which tracks a large basket of regional banks, is down 5% year-to-date.
However, some data points suggest there are some solid trends at play for large regional banks. 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.
“Ratings for all banks in Fitch Ratings’ annual U.S. large regional bank peer review were affirmed last month, supported by still-benign asset quality amid controlled loan growth, ample liquidity and capital. Stable Ratings Outlooks were maintained on all but one bank, ZION, which remains on Rating Outlook Positive,” said Fitch Ratings in a note out Monday.
Opportunistic traders who want capitalize on the short-term volatility have a number of leveraged and inverse ETF options to enhance potential returns. For instance, the Direxion Daily Regional Banks 3x Bull Shares (NYSEArca: DPST) can capitalize on short-term views on further strength in the financial sector, or the Direxion Daily Regional Banks 3x Bear Shares (NYSEArca: WDRW) can express short-term hedge of the opposite.
Risks to Consider With Regional Banks
While most large regional banks have favorable credit ratings, there are some risks to consider.
“While credit quality trends remain favorable, Fitch views the buildout of credit card and other forms of unsecured variable-rate consumer debt in the late stage of the economic cycle as a potential risk,” said Fitch. “Consumer exposures have been building through direct lending as well as indirect platforms such as partnerships or bolt-on investments. The median YOY growth rate of credit cards was 8.7%, about a point and one-half above the FDIC average.”
IAT, which tracks the Dow Jones U.S. Select Regional Banks Index, holds 59 stocks. US Bancorp (etftrends.com/quote/USB) and PNC Financial Services Group Inc. (etftrends.com/quote/PNC) combine for a quarter of IAT’s roster. Large regional banks are also rewarding shareholders with higher dividends and increased buybacks.
“We estimate that, at the median, total capital payout will be at around100% of net income if share buyback programs are fully executed, which is somewhat of a ratings constraint in the near term. Aside from technology spending, excess capital will most likely be directed toward further smaller acquisitions or investments in non-bank areas such as insurance, capital markets and fintech,” according to Fitch.
For more information on the banking sector, visit our financial category.