KRE Worth Another Look After Bank Bailouts

Banking stocks remain center stage of the circus, after the implosion of Silicon Valley Bank and Signature Bank, the cratering of First Republic Bank shares and the rescue of Credit Suisse. 

Ironically, investors are turning to an exchange-traded fund that tracks regional U.S. banks in an effort to navigate the turmoil. A steady stream of investments is coming into the SPDR S&P Regional Banking ETF (KRE), which has risen after an initial massive price drop when SVB failed.   

SVB was the fifteenth-leading U.S. bank, with over $200 billion in assets. It and Signature failed to meet their obligations when a tidal wave of withdrawals forced them into bankruptcy.  

Rising interest rates challenge financial institutions’ investing deposits. While buying government bonds is safe when held to maturity, early liquidation is another story, as hawkish monetary policy and quantitative tightening have caused significant mark-to-market losses on long bond positions.  

SVB and Signature purchased bonds, and the mark-to-market losses made it impossible to fulfill a sudden rush of withdrawals from on-demand depositors. SVB was one of the leading funding sources for small cap emerging technology companies, which could lead to fewer opportunities for the small cap sector and increasing acquisitions by cash-rich companies.  

Last week, concerns about Credit Suisse magnified the crisis. The U.S. calmed the waters with guarantees for deposits but not for the bank’s equity holders. In Switzerland, a liquidity injection relaxed the concerns before UBS agreed to buy the bank for $3.25 billion.  

The ECB raised rates by 50 basis points on March 16, which markets took as a sign that the central bank does not see further banking woes or systemic risk on the horizon.  

KRE’s Plunge on the Banking Woes 

Meanwhile, some investors bought the dip, turning to KRE after the shares fell off a bearish cliff during the recent events.  

At $43.86 per share on the afternoon of March 20, KRE had $3.20 billion in assets under management. KRE charges a 0.35% expense ratio and trades an average of nearly 30.2 million shares daily, making it a highly liquid product.  

KRE reflects the price action of the S&P Regional Banks Select Industry Index, a modified equal-weighted index, with quarterly rebalancing. KRE has 144 component stocks, with the top ten comprising around 20% of the exposure.  

Source: ETF.com 

The three-year chart above shows the decline from $65.31 on Feb. 3, 2023, to $41.92 per share on March 13, a 35.8% drop in just over a month, to its lowest price since November 2020.  

Banks tend to be less volatile than other stocks, but the bankruptcies caused by a rush of withdrawals also resulted in a herd of sellers in regional bank shares.  

Buying KRE on the Dip 

At over $46 per share on Friday, March 17, buying had appeared at the low, pushing KRE higher.  

Source: ETF.com 

ETF.com’s Fund Flow tool shows that $1.595 billion flowed into KRE from March 13, the day KRE reached its low, until March 17. 

In a March 15 Tweet, Eric Balchunas pointed out that KRE “took in a record $1.1b in new cash yesterday, the most among all ETFs.” 

Asset prices increase when buyers outnumber sellers, and many market participants used the significant decline in KRE to establish or increase long positions.    

Regulators and Managers: Shared Guilt 

Following the 2008 financial crisis, Dodd-Frank legislation created a regulatory framework for banks’ capital adequacy. The Federal Reserve conducts periodic stress tests that can identify undercapitalized institutions at risk of bankruptcy when market volatility creates either mark-to-market or realized losses that prevent them from meeting on-demand deposit obligations.  

The previous administration exempted banks with assets below $250 billion from some Dodd-Frank regulations. Ironically, former U.S. Congressman Barney Frank, co-author of the legislation, was on Signature Bank’s board and lobbied for the exemption for banks with assets between $50 billion and $250 billion, arguing the smaller banks do not threaten systemic risks for the banking sector. 

Meanwhile, the recent government actions have contradicted the importance of midsize banks extending deposit guarantees for uninsured depositors at SVB. The government also set up an emergency Federal Reserve Bank Term Funding Program to extend liquidity to troubled banks and insulate the financial system from contagion. A March 15 Wall Street Journal opinion piece was subtitled “The Federal Reserve fails to account for interest-rate risk.” 

Despite the easing of banking rules, the bottom line is that regulators should have realized that the trajectory of interest rate hikes and the quantitative easing program battling inflation significantly impact financial institutions of all sizes. Bank failures can have a domino effect, the definition of systemic risk. The Fed, FDIC, policymakers and all financial regulators fell asleep at the wheel.  

Management at Silicon Valley Bank and Signature Bank did not manage the on-demand deposit risks and are responsible for the failures. Still, the regulators share responsibility as their oversight was under-sight.  

The reactive government regulators will likely scramble to ensure regional banks comply and have the proper risk dynamics, which could be a bullish factor for KRE and other bank ETF products.