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Regional bank stocks are floundering amid widespread fear about the stability of the banking sector, but does that mean they could be a good buy for investors?
Shares of PacWest Bancorp — a regional bank based in California — tumbled more than 50% on Thursday, continuing a selloff that began earlier in the week. The major losses followed a report from Bloomberg News that the bank was considering a sale of some of its assets.
PacWest has been struggling in the wake of the Silicon Valley Bank (SVB) and Signature Bank failures this spring, when concern about those banks' balance sheets (and ability to cover deposits) sparked a crisis in customer confidence. Despite PacWest's attempts to reassure investors it was stable, pervasive worries about the health of regional banks continued to drag on shares.
PacWest isn't alone. Shares of Western Alliance tumbled as much as 38% and shares of First Horizon fell 33% during the turmoil. Shares recouped some of their losses Friday morning, but worries about the sector are far from over.
Amid the chaos and uncertainty, experts say the stocks of struggling banks are undervalued and some investors have been looking for opportunities. Bank stocks are also attracting interest from short sellers, who profit when stocks drop: Betting against regional banks has yielded $7 billion in paper profits so far this year, according to data cited Friday by Bloomberg.
So are regional banks actually a good investment right now? Here’s what you need to know.
Regional bank stocks are cheap — but risky
Right now, bank stocks in general are "incredibly cheap," John Ingram, chief investment officer of Crestwood Advisors, tells Money. “It's very much an opportunity.”
But that doesn’t mean investors should pile in. Ingram emphasizes the lessons from SVB’s recent collapse: Bank losses, and even bank failures, “can happen almost overnight.”
He’s not the only one issuing a warning. Right now, regional bank stocks are a “high-risk investment,” says Alexander Yokum, an equity research analyst at CFRA Research. A lot of that risk comes down to investor confidence, he says.
“If everybody gets bearish on the same bank at the same time, it can create a problem where there wasn't necessarily one,” Yokum says.
If a bank fails, Ingram says investors shouldn’t expect a bailout, either, since he doesn't anticipate that regulators will compensate common stockholders for their losses. “So there's a big, big risk here.”
Keep in mind that it’s a very different story for depositors, whose money (up to $250,000 per person, per account, per institution) is protected by the Federal Deposit Insurance Corporation (FDIC).
Why are bank stocks so risky?
The risk that regional bank stocks carry is unique. Unlike during the Great Recession, when deteriorating credit prompted banks to fail over a period of months, this spring’s crisis appears to have been driven in part by rapid communication among customers, including on social media, that pushed banks to the breaking point in a matter of days.
“The number one driver of stock performance right now is fear, not fundamentals,” Yokum says. Depositors who get wind of trouble in their own bank or even a different bank can pull their money out incredibly quickly. Word spreads, leading to more withdrawals and stress on the bank’s balance sheet, followed by major stock losses.
This contagion effect makes it incredibly difficult to predict how a given stock will perform, even if that stock is fundamentally sound. In the long term, Yokum says he believes these banks have strong fundamentals that will see them through the crisis and even allow them to outperform, but in the short term, he says investors should be prepared for big losses.
Is the banking sector sound?
In general, many experts say the U.S. banking system isn’t at risk of another major crisis. Earlier this week, Federal Reserve Chair Jerome Powell emphasized that the sector is “strong and resilient.”
Yokum says that if banks can weather this short-term crisis without huge losses in deposits or a major decline in credit quality, “there is a good chance they'll outperform because the valuations are so low.”
He adds that an announcement about an increase in deposit insurance from the FDIC — something that some experts have proposed could make depositors feel more confident that their money is safe and prevent more bank runs — could be a catalyst for a major rally.
While Yokum is also bullish (meaning he believes the stock prices will rise) on a few regional banks that he says are well diversified and are actually seeing deposit inflows, like Fifth Third Bank and PNC, he says even healthy banks could be exposed to risk because of how interconnected the banking sector is.
Despite the potential opportunity, Ingram says he “wouldn’t advise” investments in individual regional bank stocks because of how difficult it is to predict whether investors and depositors will remain confident in a certain bank.
How to invest in regional bank stocks
During a tumultuous period for the sector, the risks of investing in regional bank stocks might not outweigh the potential rewards.
But for determined investors, there are ways to gain a little exposure to the sector without buying shares of one individual stock. Ingram says an exchange-traded fund (ETF) like the SPDR S&P Regional Banking ETF, which holds 143 regional and community bank stocks, would be one easy way to invest and eliminate the risk to your portfolio should a single bank go under.
Keep in mind: Financial advisors tend to say it’s not a good idea to focus on investments in individual stocks. It’s much less risky to build a diversified portfolio, tailored to your individual goals and risk tolerance, that allows you to invest across the entire market. That way, when there’s major disruption in one sector (like banking), you aren’t exposed to severe losses like PacWest saw this week.