What happened

Stocks of several regional banks fell by more than 35% in the first half of 2020, according to data provided by S&P Global Market Intelligence. These included four banks with current market caps of between $10 billion and $13 billion:

  • Cincinnati-based Fifth Third Bancorp (FITB 2.26%), with shares down 37.3% in the six months ended June 30, 2020
  • Rhode Island-based Citizens Financial Group (CFG 2.12%), shares of which fell 37.9%
  • M&T Bank (MTB 1.17%), based in Buffalo, New York, whose stock tumbled 38.8%
  • KeyCorp (KEY 2.51%), headquartered in Cleveland, saw its shares drop 39.8% in the first half of the year

Overall, these results were typical of the regional bank sector as a whole. Here's why.

A man ducks below a chalk drawing of a breaking arrow.

Image source: Getty Images.

So what

Banks of all sizes, in all regions of the country, were hit with the one-two punch of lower interest rates, which affect the profitability of loans they write, and skyrocketing unemployment, which often causes default rates on existing loans to rise. 

In the first half of March, the Fed cut the target federal funds interest rate twice: a 50 basis point cut on March 3, followed by a 100 basis point cut on March 15. That dropped the rate from a range of 1.5% to 1.75% down to a range of 0% to 0.25%, the lowest possible range without going negative. Meanwhile, the yield on the 10-year T-note was more than halved, falling from above 1.5% in mid-February to just 0.7% at the end of March.

Regional banks' net interest margins were suddenly getting squeezed: The profitability of their new loan underwriting would be severely curtailed, but due to the suddenness of the drop in rates, the interest rates they had promised to existing depositors would be steep by comparison. Some banks, Fifth Third in particular, had already been reducing their deposit interest rates in anticipation of rate cuts by the Fed, but no bank is completely immune. 

The banks also weren't immune to potential loan defaults due to the coronavirus-related unemployment surge. Their first-quarter profits tumbled as they moved assets onto their balance sheets in anticipation of a large number of loan writedowns. KeyCorp, for example, more than tripled its provision for credit losses, to $359 million. Fifth Third even announced it would hire 950 new workers to handle the flood of requests for loan modifications and other financial relief.

Amid all the bad news, it's worth mentioning that many regional banks got a benefit in 2020 as well, in the form of a change to the Dodd-Frank regulations. Congress adjusted the definition of a systemically important financial institution (SIFI), which is a major financial company that is subject to increased regulatory requirements, including more rigorous stress testing. Previously, the SIFI designation applied to banks with as little as $50 billion in assets, but now that floor has been raised to $250 billion. None of these four banks are anywhere close to that threshold, and weren't even before the coronavirus pandemic. They only held assets of between $119 billion (M&T) and $169 billion (Fifth Third) at the end of 2019. But that's a pretty thin silver lining amid all the economic turmoil the banks are experiencing. 

Now what

Citizens Bank CEO Bruce Van Saun said it well in the bank's Q1 2020 earnings call: "We are in the midst of unprecedented times with the coronavirus representing an unseen enemy that's wreaking havoc with people's lives and with our economy." Until that unseen enemy is defeated -- or until significant progress has been made toward defeating it, at least -- the economy will remain upended and bank stocks are unlikely to recover. That makes it a risky time to invest in regional banks.

All four of these banks are currently trading well below their book values (and all but M&T are even trading below their tangible book values), which could make them attractive acquisition candidates for larger banks that are looking to expand into these regions. If word of a potential acquisition leaks, you can expect a bump in share price. But there's no way to predict that in advance. 

Risk-tolerant value investors who can afford to hold onto these stocks as they wait for an eventual recovery might want to look closer, but most investors will probably want to steer clear for now.