Regional banks: A league of their own?
As the first months of the new administration unfold, one sector that seems poised to benefit from both lighter regulation that the Trump administration promises, as well as the Federal Reserve’s (Fed’s) path toward higher interest rates, is financials. Within the financial sector, regional banks may be particularly well positioned due to their simplified, lending-focused business models.
As the name suggests, regional banks are depository institutions that operate across groups of states but below the national level. These organizations could see potentially significant regulatory relief under the new administration if they are legally differentiated from larger, more complicated bulge bracket banks, which represent the country’s largest multinational investment banks.
For example, there are proposals to raise the $50 billion threshold for “Systemically Important Financial Institutions” (SIFIs), a Dodd-Frank designation for 33 banks whose failure could trigger a financial crisis. With many regional banks at present grouped alongside bulge brackets under the current minimum, increasing the threshold could grant regional banks more operational freedom than their larger peers.
Broadly speaking, regional banks earn revenue from lending and pay fees on deposits. When interest rates edge higher, the spread between income from loans and payments on deposits typically widens, which can help increase bank profitability through higher net interest margins (NIMs). Although the low interest rate environment over the past decade has compressed bank NIMs, we expect U.S.-led reflation—rising nominal growth, wages and inflation—to accelerate. Refer to the chart below.
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Markets could also be underpricing the possibility of more and larger rate hikes in 2017, given the Fed’s apparent increasing confidence in job and wage growth. This has paused further steepening in the U.S. Treasury curve, but yields could rise when the Fed signals more aggressively.
Due to their lending-focused business models, regional banks may be among the best-positioned financial firms to capitalize if or when Fed action causes interest rates to increase.
In addition, regional banks’ relatively simplified structure could also make them more resilient to capital market headwinds than larger banks. The largest U.S. banks have seen fluctuating trading revenue in recent quarters, particularly in fixed income, while regional banks have typically not engaged in such activities. Regional banks also tend to be more domestically-focused, meaning their bottom lines may be less impacted by a strong U.S. dollar, which could potentially erode non-dollar revenue earned abroad.
However, it is important to note valuations have increased significantly since the election, as investors anticipate an easing of financial regulations. This, of course, potentially sets the stage for disappointment (and a selloff) should that not occur.
Nonetheless, regional banks may stand to gain the most among financials from regulatory easing and a more favorable macroeconomic environment—assuming both occur. Larger banks may still perform strongly in a reflationary environment and may serve as a portfolio diversifier.
Investors looking to access regional bank equities may want to consider iShares U.S. Regional Banks ETF (IAT). For broader financial services, consider iShares U.S. Financial Services ETF (IYG).
Heidi Richardson is Head of Investment Strategy for U.S. iShares and a regular contributor to The Blog.
Heather Apperson and Madeline Zeiss contributed to this blog.Carefully consider the Funds' investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds' prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader. The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective. The information presented does not take into consideration commissions, tax implications, or other transactions costs, which may significantly affect the economic consequences of a given strategy or investment decision. This post contains general information only and does not take into account an individual's financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision. Funds that concentrate investments in specific industries, sectors, markets or asset classes may underperform or be more volatile than other industries, sectors, markets or asset classes and than the general securities market. Diversification and asset allocation may not protect against market risk or loss of principal. ©2017 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. All other marks are the property of their respective owners. RO-128830 http://hvst.co/2op9ExK
Originally Published at: Regional banks: A league of their own?