2023-10-18 15:15:25 ET
Summary
- Credit contraction and trouble in regional banks suggest caution in buying into the sector.
- The iShares U.S. Regional Banks ETF provides targeted access to domestic regional bank stocks.
- The underperformance of regional banks compared to larger financial institutions highlights the small-cap dynamic in the sector.
I don't have a bank account because I don't know my mother's maiden name. - Paula Poundstone.
Remember the regional bank crisis?
Yeah.
Me neither.
That doesn't mean it's gone away, though. Credit contraction is underway, and the hemorrhage in Treasuries suggests banks remain in trouble. Some might be tempted to buy into regional banks after their severe breakdown which started in March, but I don't think the time is right just yet. When it is, though, exchange-traded funds ("ETFs") like iShares U.S. Regional Banks ETF (IAT) can be a good way to gain exposure.
The iShares U.S. Regional Banks ETF is designed to track the investment results of an index composed of regional banks within the United States. The ETF provides investors with targeted access to domestic regional bank stocks, making it an interesting bet on the U.S. banking industry. The fund holds 35 securities, which makes it a somewhat concentrated portfolio. The top three positions, namely PNC Financial Services (PNC), U.S. Bancorp (USB), and Truist Financial (TFC), account for more than 35% of the total allocation. You read that right - 3 holdings make up more than a third of the Fund. Idiosyncratic risk is high here.
Performance
The below, for lack of a better way of saying it, is an ugly chart for IAT. You can clearly see what happened in March of this year. While there's a temptation to buy low here, momentum really hasn't started and the macro backdrop I think makes it challenging to argue a new bull market will begin here any time soon.
Having said that, it does seem possible that this will become a big trade in the future. I just think we need to wait for a broader macro dislocation (which may be underway) to really get the most out of it.
Peer Comparison
The difference between the regional bank sector and broader financials is pretty incredible when you zoom out. Regional bank stocks have been underperforming the broader sector for many years. When you look at the price ratio of IAT relative to the Financial Select Sector SPDR ETF ( XLF ), it's clear that betting on the big banks has been far better than the small ones. Again - this isn't necessarily a bad thing, but I do think it puts the large versus small cap dynamic in context here.
This is an underappreciated aspect of investing in regional banks. It's more than just a question of the fundamentals. It's also a question of broader market capitalization. The majority of this fund is in the mid-to-small-cap range. This matters from a cycle perspective because the reality is we've been in a decade-long period of large-cap dominance in general, where small and mid just haven't been able to keep up. This will change at some point, but we are still in that world now.
Risks
One of the primary risks is related to the macro backdrop, characterized by rising interest rates and market volatility. These factors can significantly impact the profitability of regional banks and, consequently, the performance of the ETF. Additionally, recent failures of several banks have raised concerns about the stability of the regional banking sector.
I do think there can be a big trade here at some point, and iShares U.S. Regional Banks ETF is a good fund for what it does. Just be mindful of the concentration risk in the top 3 holdings, and what further volatility would do to the banking sector overall.
For further details see:
IAT: Not The Time