Bank stocks surged after Pfizer released promising data on its coronavirus vaccine Monday -- and regional banks did best of all.
On the day of the announcement, the SPDR KBW Regional Banking ETF (NYSEMKT:KRE), which tracks regional bank stocks, climbed by 15.4%, That result beat both the KBW Nasdaq Bank Index, which tracks large bank stocks, and the NASDAQ OMX ABA Community Bank index, which tracks smaller bank stocks. Those two rose roughly 13.5% and 12.8%, respectively.
The gap between those market responses can be attributed to a key difference in those bank classes' business models. It's a difference that ties the health of regional banks somewhat more closely to the state of the pandemic than both their larger and smaller counterparts, and suggests that they'll benefit a bit more from the swift arrival of a vaccine.
A higher percentage of loans on the books
The coronavirus pandemic has weighed significantly on the banking sector because it has hurt the businesses and individuals that banks lend to, creating the potential for significant loan losses.
This is especially true of regional banks. While megabanks like JPMorgan Chase, Bank of America, and Citigroup have more diversified revenue streams, traditional regional banks are more tied to their loan books and the economic conditions in the markets where they do the bulk of their business.
For instance, let's compare the three megabanks above with the three largest traditional holdings in the KBW Regional Banking Index. Loans make up about 55% of Fifth Third Bancorp's total assets; 62% of Regions Financial's assets; and 63% of Truist Financial's. By contrast, loans only make up roughly 30% of JPMorgan Chase's total assets; 35% of Bank of America's assets; and 29% of Citigroup's.
A higher percentage of loans means the potential for a higher level of losses. It also could make generating revenue more difficult in the current ultra-low interest rate environment. The Federal Reserve has made it clear that it's not going to raise benchmark interest rates until the economy is much healthier, and widespread distribution of a COVID-19 vaccine will be crucial to getting that recovery started. Because the big banks generate larger amounts of their income from segments such as investment banking and asset and wealth management, they shouldn't feel as much of a pinch from low interest rates as their regional bank counterparts.
A vaccine could mitigate loan losses
If an effective vaccine (or more than one) reaches the public sooner rather than later, that improves the odds that borrowers will be able to make their payments, and that banks will end up with fewer charge-offs (debt unlikely to be collected) than they are currently anticipating.
Consider M&T Bank (NYSE:MTB). As of Nov. 4, its stock had fallen by 42% year to date -- the steepest decline among the SPDR KBW Regional Banking ETF's top 10 holdings. Investors have been worried about the historically strong bank because 9% of its loan book is tied up in the hard-hit retail and hotel sectors, and a good chunk of that is to businesses in New York City, which was an early epicenter of the pandemic. After Pfizer released its interim phase 3 trial news on Monday, M&T's share price jumped by more than 25% -- a sharper rise than perhaps any bank stock that day.
The sooner a working vaccine is distributed, the sooner the economy can begin properly recovering. Banks still expect heavy loan losses to start hitting in the back half of 2021. If Congress can agree on another major economic stimulus package soon, that forecast could be pushed out even more.
So, if a large percentage of the population gets vaccinated in 2021 and economic conditions improve, it's likely that more borrowers will get through the year on better financial footing, and be able to make their loan payments. An overall lower level of loan defaults should benefit regional banks more than the sector as a whole.