New Bull Market for Regional Banks? Not So Fast

Commentary 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 below what I believe are areas of current and future stress facing the banking sector: 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 Treasurys when the Federal Reserve 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 banking crisis in spring 2023, when the Fed and Federal Deposit Insurance Corp. (FDIC) had to intervene with a bailout of $500 billion-plus, guaranteeing all deposits. Regional banks are now facing a highly inverted yield curve, which impacts net interest margin—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 deposits. The discount rate (which banks pay the Fed to borrow money) is currently at 5.5 percent. 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 more than $550 billion, each of which had to be resolved by the seizure and sale of assets. They are listed below:...