Shying Away from Regional Banks: Opportunity Amidst the Risks

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Bill Gross, the one-time bond king, has been consistently warning against investing in regional banks. He even compared the sector to a “falling knife” in a recent tweet on X (formerly known as Twitter). However, even in his bearish assessment, Gross acknowledges that there is “extraordinary long-term value” in this sector as some names begin to trade at 60% of book value and offer attractive 7% yields.

While Gross’s broad thesis for regional banks focuses on their potential long-term value, the higher yields they offer might be even more enticing than their trading well below book value. Gross expressed his optimism about the sector, stating, “There is much value there. Today’s action is very encouraging. Despite my earlier tweet, I’m buying a little,” in an email through a spokesperson.

On Monday, the SPDR S&P Regional Banking ETF (ticker: KRE) experienced a 1.5% increase in trading, outperforming the 1.2% gain seen in the S&P 500. However, Gross isn’t concerned with the index performance; he has specifically targeted three banks for investment: Citizens Financial Group (ticker: CFG), Truist Financial Corporation (TFC), and KeyCorp (KEY). Gross’s spokesperson confirmed that he has been buying “a little” of these banks.

All three banks offer impressive yields above 7% and are trading below book value, although not as low as Gross initially tweeted. Citizens Financial Group meets both criteria, trading at 50% of book value as of the third quarter’s close. Truist Financial Corporation trades at 68% of book value, while KeyCorp trades at 87%. Even still, considering that Treasuries are offering a 5% yield, these banks’ yields above 7% present compelling opportunities.

Gross also expressed his views on the broader regional bank sector in a recent tweet. He stated that he is waiting to make purchases but considers these banks to be “great long-term holds.” Despite the risks involved, Gross sees potential in the regional banking sector and believes that careful investments could yield fruitful results.

The Troubled State of the Banking Sector

As with many other market participants, Bill Gross shares a similar apprehension about the current state of the banking sector. The Federal Reserve’s efforts to reduce inflation by increasing interest rates have caused significant problems for banks. In fact, this has directly contributed to the collapse of three regional banks earlier this year. While it is not expected that other banks will suffer the same fate as Silicon Valley Bank and others, their securities portfolios are burdened with $558 billion in unrealized losses, according to the Federal Deposit Insurance Corp.

The majority of banks do not anticipate having to face these losses, but they are nevertheless left with “frozen assets” on their balance sheets. Barry Knapp, managing partner of Ironsides Macroeconomics, explains that small and medium-sized banks find themselves in an “unworkable situation.” This predicament is exacerbated by the inversion of the yield curve, where short-term debt rates surpass those of longer-term debt.

Knapp asserts that this situation prevents banks from growing and significantly impairs their profitability. Moreover, due to the losses on their balance sheets, many banks will struggle to provide loans. This particularly affects regional banks that heavily rely on revenue from loan interest, unlike larger peers who generate a significant portion of their revenue from fees.

Given the challenges facing banks regarding bonds, it seems plausible for a bond expert like Gross to identify potential opportunities.

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