Analysis: Moody's warning on US banks a wake-up call for sanguine investors

Pinnacle Financial Partners

10/08/2023 11:00

By Saqib Iqbal Ahmed and Nupur Anand
       NEW YORK, Aug 10 (Reuters) - 
    The slide in U.S. bank stocks this week appeared to catch
traders in the options market by surprise, data shows, raising
questions over whether bank investors have become a little too
comfortable with the sector that only months ago was in crisis. 
    U.S. bank shares dropped on Tuesday after ratings agency
Moody's downgraded credit ratings of several U.S. regional
lenders and placed some banking giants on review for potential
downgrade. 
    It warned lenders will find it harder to make money as
interest rates remain high, funding costs climb and a potential
recession looms. It also cited some lenders' exposure to
commercial real estate as a risk. 
    The warning caught some investors off guard. 
    A day before, options traders' expectations for near-term
swings in the shares of two major sector exchange-traded funds
(ETFs) - SPDR S&P Bank ETF  KBE.P  and SPDR S&P Regional Banking
ETF  KRE.P  - hit the lowest level since the collapse of Silicon
Valley Bank in March, signaling little investor concern about
the sector's outlook, data from Cboe's options analytics service
Trade Alert showed.
    On Tuesday, SPDR S&P Regional Banking ETF's  KRE.P 
options-based 30-day implied volatility rose to 31.1%, up from
28.9% touched on Monday. At 30.7% late on Wednesday, that gauge
of how much traders expect the shares to gyrate still remains
well below the high of 82% touched in March. 
    Investors appear to have made their peace with risks in the
sector and were not focused on defensive positioning, either
because they had already shed banks exposure, or were not very
concerned about fresh bad news, said Steve Sosnick, chief
strategist at Interactive Brokers. 
    "There's not nearly as much risk being priced in," he said.
        With some 1.5 put options open against each call option,
as of Wednesday, positioning is less defensive than it has been
about 80% of the time over the last four years, and a far cry
from March when there were more than 4 puts open against each
call, according to Trade Alert. 
    Calls convey the right to buy shares at a fixed price in the
future and are usually used to bet on shares rising. Put options
give the right to sell shares and express a bearish or defensive
view.
    While the S&P 500 Banks index  .SPXBK  is down about 3% for
the year, compared with a 17% gain for the S&P 500 Index  .SPX ,
it is up about 17% from the multi-year lows touched in early
May. 
       "This is more of a shot across the bow for those
investors that are getting complacent within this space," said
David Wagner, Portfolio Manager at Aptus Capital Advisors,
referring to the Moody's ratings changes. 
    
    RISKS LINGER
        The collapse of three mid-sized U.S. banks earlier this
year and record deposit outflows from smaller lenders sparked
investor concerns about the broader banking industry, but no
further bank failures and resilient economic data have helped
shore up investor sentiment since May.    
    Still, risks linger, including exposure to the commercial
real estate office sector, which has been hurt by lingering
pandemic vacancies and high interest rates, and the growing cost
to retain flight of deposits. 
        "Commercial real estate is one of the focal points for
investors. It is going to take a long time to play out and
is...one of the biggest risk factors for banks at the moment," 
said David Smith, an analyst at Autonomous Research. 
        "There has been a change in deposit mix leading to
higher cost of funding which remains a concern," he added.
    Analysts also believe that some risks from impending new
regulatory capital hikes may be under-priced, since these could
result in short-term capital pressure for some lenders.
        Some investors, though, said the biggest risks are
mostly short term. 
    Brian Mulberry, client portfolio manager at Zacks Investment
Management, which holds stocks in a number of major lenders,
said he was looking 12 to 18 months out when earnings are
expected to jump. 
    "In the near term, there are reasons for caution about banks
in general and we have made changes where appropriate," he said.
    "As interest rates go higher, the more pressure it puts on
banks' profitability, even so, we do not see this as a solvency
issue where the entire banking system will collapse." 

 (Editing by Michelle Price and Diane Craft)
 ((michelle.price@thomsonreuters.com; +12026041711; Twitter:
@michelleprice36;))