It's been several months since the volatility in the regional banking space caused by several high-profile bank failures started to calm down. But that doesn't mean the volatility in regional banking is over. Just recently, regulators revealed a plan to make some regional banks issue more debt to ensure they could cover losses in the event they fail.
To be sure, this would certainly increase funding costs for the affected banks. But even if this comes to fruition (which isn't necessarily going to happen), there are some excellent bargains in the regional banking space for patient long-term investors. Here are two in particular I've added to my own portfolio and would be comfortable buying even more shares today.
A regional bank with national bank qualities
Truist Financial (TFC 0.53%) is technically a regional bank, in the sense that it primarily operates in the Southeast and Mid-Atlantic regions of the United States. But its size isn't what you'd normally associate with the term -- in fact, with more than 2,000 branches and $565 billion in total assets, Truist is the sixth-largest bank of any kind in the U.S.
As such a large institution, Truist is considered to be a systemically important financial institution, or SIFI. This is commonly referred to as "too big to fail," and as a result, Truist is subject to far more regulatory scrutiny than other regional banks to ensure it would remain healthy in a severely adverse environment.
There are a few reasons why I like Truist and recently added it to my portfolio. For one thing, the bank has a ton of organic growth potential, as it operates in many of the fastest-growing metropolitan areas in the U.S. And although it's larger and more stable than most regional banks, it has been beaten down along with that group. Shares are down by 31% so far this year, and the stock trades for less than 70% of its book value. While it might take some time for the regional banking fears in the market to go away, in the meantime the stock pays a 7% dividend yield that is well-covered by its earnings.
As auto lending normalizes, this bank could win
Ally Financial (ALLY 0.41%) is a much smaller bank than Truist and is based online. It was spun out of General Motors in the wake of the financial crisis and was formerly GMAC Financial. So, it shouldn't be a big surprise that the bank's primary focus is auto lending.
While auto lending makes up the majority of Ally's loan portfolio, it has evolved into a full-featured bank. It offers a variety of loan types, including mortgages and credit cards, and also has a fast-growing consumer banking platform with deposit accounts, brokerage services, and more.
Because of its auto lending focus, Ally's profitability is fantastic. In the second quarter, Ally's average new auto loan had a 10.4% interest rate, and the bank's average cost on its deposit base is just 3.7%. Even when accounting for a few percentage points of loan defaults, this is a big spread.
The biggest risk to Ally right now is the prospect of a recession coming soon, which most experts are expecting. In a recession, many consumers could have trouble paying their bills, which could lead to an uptick in defaults, plus demand for new loans could decline sharply.
While these risks are certainly worth keeping an eye on, with the stock trading for a 25% discount to book value and just 8 times forward earnings, the risk-reward dynamics of this highly profitable lender look attractive.
I'm confident in adding shares of both to my portfolio
To be perfectly clear, although I think this is a great entry point into both of these well-run financial institutions, I don't envision a smooth path forward. The regulatory debate surrounding regional banks will take some time to play out, and a recession later this year or in 2024 could cause significant volatility. So, if you buy these, it would be wise to do so with the long term in mind, but while expecting a bit of a roller-coaster ride in the next couple of years.
