KRE and IAT ETFs: Regional banks brace for a $1 trillion meltdown

The SPDR S&P Regional Banking ETF (KRE) and iShares US Regional Banks ETF (IAT) have moved into a correction in the past few weeks, falling by over 13% from the YTD high. KRE has retreated to $46.83 while IAT has moved below $40. 

Extend and pretend no more

Regional banks are going through a major challenge that could affect their growth and even their existence. This challenge is that the commercial real estate industry is going through a triple whammy of high-interest rates, low demand, and upcoming maturities.

This is a notable challenge because, as I wrote last week, most of these commercial loans are held by regional banks. Bloomberg estimates that this ratio stands at over 70%. Most of these banks have become key lenders as big banks have largely pulled back from the industry. Estimates are that $1 trillion of these commercial loans will expire in the next two years.

The main reason why most regional banks have weathered this storm is that they have largely embraced an extend-and-pretend attitude. This is a situation where they extend the maturity period of loans and ignore short-term market volatility.

The goal is to hope that property values will ultimately bounce back, especially if interest rates start falling. However, there are signs that interest rates will remain higher for longer after the US published strong inflation and jobs numbers.

Most importantly, there are signs that demand for office properties will not rebound now that many companies are laying off white-collar workers. Companies like Paramount Global, Instacart, PayPal, and Cisco have laid off thousands of workers.

Further, many companies who have expiring leases will likely have a better negotiation advantage because of the rising vacancy rates now that prices are falling. In San Francisco, prices have dropped by over 40% while Manhattan, Boston, and Los Angeles have fallen by over 10%.

The implication of all this is that many property owners will opt to default instead of refinancing their properties in a high rates environment. Blackstone, the biggest private equity company in the world, recently defaulted on a Manhattan property, which was later sold at a 50% discount.

The challenge for many regional banks in KRE and IAT ETFs is that commercial real estate is an important part of their balance sheets. And unlike big banks like JP Morgan and Wells Fargo, these companies don’t have strong alternative businesses like investment banking, credit cards, and wealth management.

KRE ETF stock analysis

The KRE ETF has something more to worry about. As shown above, the fund has formed a double-top pattern at $53.37 and whose neckline is at $48.34. In most cases, this pattern is one of the most popular bearish signs. The stock has moved below this neckline and the 50-day and 100-day moving averages.

Therefore, there is a likelihood that the fund will continue falling in the coming weeks as sellers target the key support at $37.30, its lowest point on October 25th. This price is about 20% below the current price.