Regional Banking Woes Keep Getting Worse

If you subscribe to the cockroach theory of investing (where there is one cockroach, there is an army; where there is one piece of bad news, there is likely to be more in the pipeline), then the recent regional banking turmoil should come as no surprise. Fundamentally, it was just a matter of time before the subprime>housing>credit crisis started to manifest itself on the balance sheets of those regional banks in the areas that have been hardest hit by the recent economic problems.

Two quickly recap, Cleveland-based National City Corp (NCC) made the biggest headlines in late April when it received a $7 billion capital infusion from an investment group led by Corsair Capital. Just a week ago, NCC acknowledged that is operating essentially in a probationary mode governed by the contents of two memoranda of understanding with the Office of the Comptroller of the Currency and the Federal Reserve Bank of Cleveland. The details of these MOUs have not been made public.

Among the many other regional banks that have stumbled, KeyCorp (KEY), which is also headquartered in Cleveland, has been one of the more spectacular examples. Toward the end of May, KeyCorp doubled it estimates for write-offs for mortgages, HELOCs and educational loans just one month after raising write-off estimates when it reported earnings. More recently, KeyCorp announced plans to raise $1.5 billion in new capital and slash its dividend 50%.

A third Ohio bank, Cincinnati-based Fifth Third Bancorp (FITB), is dominating the headlines today, with news that the company will raise $2 billion in capital and slash its dividend 66%.

In terms of stock performance, NCC is down 75% from its December levels, while both KEY and FITB are down more than 50% since the beginning of May.

With all the turmoil in the regional banking market, I am tempted to swap out Lehman Brothers (LEH) as my official financial sector fear indicator and replace it with one of the regional banking indices. Better yet, why not make that a regional banking ETF, such as RKH (Regional Bank HOLDRS Trust), whose options status make it easy not only to keep track of price trends, but implied volatility trends (see chart below) as well.

Finally, I would be remiss in not pointing out that Ohio is the classic swing state in Presidential elections and voters go to the polls in less than five months…