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Regional banks are having a nice relief rally but it will be short lived. The small thrift and regional banks are still stuck in the same situation that has plagued them since the start of the financial crisis. Regional banks are faced with declining asset values and an unfavorable lending environment.

Regional banks were forced to write down many of their assets during the housing collapse and haven't recovered since. Many banks are unable to issue new loans due to capital requirements. Some banks have had a few pockets of growth.

FBR Capital Markets, said:

"The regional players experienced stronger loan growth largely due to smaller run-off portfolios and a greater deal of exposure to commercial and industrial lending as opposed to the residential loans that are slowing down big banks."

This could also mean commercial real estate loans could once again start being an issue for regional banks, if the economy were to slow. We saw 13 regional bank failures this April, 2011. From those 13 failed banks, FDIC reported that 79% of their non-performing loans were due to commercial real estate loans. Any sign of a slowing commercial market could once again bring havoc to the regional banks.

The feeling on wall street is that the selling has gotten ahead of itself and the bottom is in place. Analysts feel banks are in a much better situation that during the financial crisis and this type of selling is overdone.

I do agree that selling may have gotten a little ahead of itself but I don't feel that it's done. There haven't been any changes in the economy that would signal the banking industry is turning around.

Fannie Mae (OTCQB:FNMA) recently said:

"Key factors, including revisions to gross domestic product data, have revealed that we have a bigger hole to dig out of, which explains the consumer angst over the lack of employment growth."

Doug Duncan, Fannie Mae Chief Economist said:

"European financial market and fiscal policy turmoil, coupled with the U.S. Debt ceiling debate, have hit on consumer confidence, which is at recessionary levels."

Fannie Mae barely stopped short of predicting another double dip recession. I think we are going to see the economy slow and that will have an impact on the banks. The government will likely try to stimulate the economy, but given our current deficit, I don't see any permanent actions they may be able to take. There have been a lot of talk about QE3 but I don't see how our government could afford it at this point.

I'm short term bearish on the regional banking sector and looking to flip long once I see the economy stabilize. I'm long term bullish on the banks, but I feel I could get a better entry price if I were to wait for the next move down. For those that are long, I don't necessarily think you have a bad trade, just that you may be able to get a better price if the economy continues to slow.

You could play this trade through the Proshares Short Regional Bank ETF (KRS). If you want to buy into the pullback you could play this through the SPDR Regional Bank ETF (KRE).

Source: Whether The Regional Banks Recovery Has Legs