Banking stocks have been among the worst performing stocks of 2011. There are a few primary headwinds facing banks that have led to the disaster that was 2011.
- Europe. The European banking crisis has led to fears of massive systemic fall out. Through complex vehicles such as credit default swaps, American banks are believed to be at significant risk in the event of an EU collapse.
- Mortgage put-back litigation. The mortgage put back issue has been a major issue for the banks in 2011. Government agencies and mortgage insurers have proved that their cases have some merit for example look at the settlement Bank Of America (BAC) just made.
- Slow growth. Banks have faced a drought of growth as consumers are simply borrowing less. Investors have decided that these stocks simply are not worth the multiples of the past because growth will remain weak for some time.
All of these issues have had a greater impact on the large banks (JPM, BAC, WFC, C, etc..) than the regional banks (USB, PNC, BBT, etc...) A chart of the SPDR Regional Banking ETF (KRE) (blue) and SPDR Banking ETF (KBE) (orange) is shown below.
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KRE has done significantly better than KBE. This is indicative of the fact that regional banks face less of the previously mentioned headwinds.
- Regional banks simply do not have the exposure to Europe that Large banks have. Regional banks do not have significant operations in Europe, thus they have little reason to be exposed.
- Regional banks still do face mortgage litigation risks, but the risk are not as great as the large banks. Due to their reduced size, the regional banks tend to have a better handle on what exactly they own. Contrastingly, large banks have a difficult time breaking down smaller groups of mortgage securities.
- Regional banks have better growth opportunities than large banks for a few reasons. Firstly, regional banks are not as big as large banks, this means they have more room for growth. Secondly, regional banks are positioned to benefit from asset sales from larger banks looking to de-leverage. Regional banks also tend to do less trading and sales business. Trading and sales has been a weak spot for many larger banks.
Regional banks are in a better place than large banks, but do the stocks already reflect this?
The stocks are beginning to reflect this, but the trade is not done yet. Regional shares have only just started to outperform their larger rivals. Up to October, KBE and KRE had been down about the same for the year. Since the lows in October, KRE has outperformed by nearly 20%. This is significant outperformance for any two sectors, let along 2 mini sectors. This move suggests that real change is occurring in how the market views the regional bank stocks. The market is just starting to give the regionals credit for the better position that they are in, and this is likely to continue into 2012. Of course, if things continue to get worse in Europe the regional shares will still go down. However, the drop in the regional shares is likely to be far less than in large bank shares.
How to play it:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.