Key Takeaway
One sector that has been getting less market attention has been regional banks. Unlike their larger peers, regional banks operate on a simpler business model—earning long-term interest revenue from loans, paying customers at short-term interest rates for their deposits and profiting from the difference between the two. Looking at the difference between those two rates, commonly referred to as the yield curve, gives a general measure of profitability. The steeper the yield curve is, the more profitable regional banks are expected to be.
Looking below at the historical relationship between the yield curve and a regional bank index fund (KRE), when the yield curve turned negative in the middle of 2022, the market kept going before dropping 43% in a matter of weeks. Since then, the index and the yield curve have moved in tandem and as the difference between these rates has steepened over the last year, regional banks have done exceptionally well. Since February, however, the difference between short-and-long term rates has begun to narrow again while regional bank stocks keep climbing. Does this indicate a correction on the horizon?
Across the industry, banks are reporting more competition for deposits. The Ohio-based Huntington Bank, for example, is building several new brick-and-mortar locations in the Carolinas over the next few years. Truist, PNC Bank and Regions Bank are also expanding in the Southeast, increasing their yield on deposits to attract customers. As these increased costs go up, investors may shy away from this sector. On the revenue side of the business, sluggish growth in commercial real estate has made the customer pool smaller. This sector represents about 44% of total lending for regional banks, and higher interest rates have made borrowing more difficult.
Looking ahead, regional banks on the whole face less growth potential than their larger counterparts. Because of their business model, they remain very exposed to changes in interest rates, making regional bank stocks possibly more reactive to interest rate decisions by the Federal Reserve.
This material is for informational purposes only and is not intended as investment, tax, or legal advice. Past performance is not indicative of future results.
See how we can help you reach your financial goals
Markets shift, but a properly structured financial plan should be able to handle whatever comes next. Schedule a complimentary meeting with our team to talk through what this update means for your portfolio and your goals.