What’s Up With Banks?

January 26, 2012

On Friday, three small banks closed their doors—the first such closures of 2012.

It made me wonder. In 2011, small banks far outperformed larger institutions.

But could the shuttering of First State Bank in Stockbridge, Ga., the Central Florida State Bank and American Eagle Savings Bank mean the outperformance of smaller banks has run its course?

The chart below shows the indexes tracked by three major U.S. Banks ETFS: the PowerShares KBW Bank Portfolio (NYSEArca: KBWB), the iShares Dow Jones U.S. Regional Banks ETF (NYSEArca: IAT) and the SPDR S&P Bank ETF (NYSEArca: KBE).

I used index, rather than ETF, data because KBWB launched in November 2011. That’s just too recent for credible analysis, plus KBE switched its underlying index in October 2011.

The ETF KBWB tracks the KBW Bank Index, while iShares’ IAT tracks the Dow Jones U.S. Regional Bank Index. Also, SSgA’s KBE now tracks the S&P Banks Select Industry Index (SPSIBK).

KBE includes the 24-largest banks in the United States, weighted in a modified-market cap scheme. I wrote about the weighting scheme in an earlier blog, The KBW Index Shuffle.

KBE equally weights all Nasdaq- and NYSE-listed U.S. banking stocks—thus, it underweights the big banks and tilts to the smaller ones. Finally, IAT, the iShares fund, only includes small banks, weighted by their market capitalizations.

1-Year Bank Indexes

As the big banks got hammered by their exposure to European debt, smaller banks suffered a little bit, but ultimately recovered by the end of the year.

Adding some of the big banks into the graph adds a little color to the picture:

1-Year Bank Indexes

The banks all tend to move in the same direction as each other, but Citigroup’s plummeting stock didn’t pull IAT’s index down nearly as much as KBWB’s.

Since the beginning of 2012, the banks, as well as indexes that hold them, have started to recover—again driven by their big holdings. As Wells Fargo and JPMorgan recover, KBWB has been outperforming the smaller IAT.

1-Year Bank Indexes - YTD

Still, as you can see from the graph above, returns are far from steady. According to Yahoo Finance, Wells Fargo currently has a beta of 2, and JPMorgan isn’t far behind, with a beta of 1.58. Citigroup is the most volatile of the group, with a beta of 3.

In contrast, KRX’s largest holding—U.S. Bancorp—has a beta of only 1.23.

It appears that, contrary to the general state of affairs, the high-beta play in banks is now the large-caps, while the comparatively low-beta play is small-cap banks.

The moral of the story is to still be very careful about investing in the banks. Paul Baiocchi made a similar point a month ago about avoiding Bank of America.

If you’re sure about getting back into the banks, be certain you understand exactly what you’re getting into. If the economy continues to recover, these banks may return impressive figures. If, however, debt concerns resurface or the economy enters another free fall, they can also be very dangerous.

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