In business, cash is king as it is vital to pay expenses, repay debt, set a dividend policy, reinvest to achieve growth, etc. Where do banks fit into that picture? As safe storing houses for cash that make their money off of lending out said cash, banks are in a prime spot to grow along with the overall economy.
Regional banks are especially tied to local economies as they often take on risks that the bigger banks turn their noses up at, or that require specialized local expertise. However, this also means they face more business risks that can impact their operations and financial performance. The most notable ones are economic conditions, credit risk, interest rate risk, market competition and the regulatory environment.
Major risks for regional banks
Regional banks are particularly susceptible to fluctuations in local or regional economic conditions. If the region experiences a downturn or recession, it can lead to a decrease in lending activity, higher loan defaults and reduced demand for banking services. Regional banks face credit risk when borrowers fail to repay their loans. This risk is elevated if a significant portion of their loan portfolio is concentrated in a particular industry or geographic area. Deterioration in credit quality, such as an increase in loan delinquencies or defaults, can negatively impact a regional bank's profitability and capital adequacy.
Regional banks are exposed to interest rate risk, especially if their loan portfolios consist of long-term fixed-rate loans. Fluctuations in interest rates can impact a bank's net interest margin, which is the difference between interest earned on loans and interest paid on deposits. A rise in interest rates can reduce profitability if the bank's cost of funds increases more than the interest income it earns.
Like all banks, regional banks must comply with a wide range of regulations related to lending practices, capital adequacy, consumer protection, anti-money laundering and more. Failure to comply with these regulations can result in financial penalties, reputational damage and potential loss of business. Regulations may seem like a hindrance, but without them, banks would be free to engage in shady business practices, and they may even have a higher chance of failure.
Digital innovations
As banking becomes increasingly digital, regional banks face risks related to technology and cybersecurity. They need to invest in secure and robust IT infrastructure to protect customer data, guard against cyber threats and ensure uninterrupted service delivery. Failure to address these risks adequately can lead to financial losses, customer distrust and reputational damage.
Regional banks often operate in highly competitive markets. They face competition from larger national and international banks, non-banking financial institutions and emerging fintech companies. Technology has increased the competitive risks. Increased competition can erode market share, squeeze profit margins and require investments in technology and innovation to stay relevant.
Liquidity and risk
Banks need to manage their liquidity effectively to meet their funding obligations and maintain adequate cash reserves. A sudden loss of liquidity due to deposit withdrawals or inability to access funding sources can severely impact a bank's operations and solvency. Changes in the geopolitical landscape, government policies, or regulatory frameworks can significantly impact regional banks' liquidity.
It's important to note that the risks faced by regional banks can vary based on their specific business models, geographical locations and market conditions. Banks employ risk management practices and strategies to mitigate these risks and ensure their long-term sustainability.
Liquidity risk has become a hot topic after several high-profile bank failures. Due to these events, the Federal Reserve may be implementing stronger regulations on regional banks because it wants to protect the U.S. banking system overall. To be clear, I think the recommended actions are justified. A strong banking system is a running engine for the health of the broader economy. However, that doesn't mean all regional banks will benefit from the investor's point of view.
Strong capital requirements mean possible rising regulatory costs
Testifying before the House Financial Services Committee on June 21, 2023, Fed Chair Powell stated, "Strong capital requirements means we have a stronger banking system... yet we also know that at the margin, as the costs of capital for banks goes up, the costs of credit goes up... You just have to make a judgment call on that, and that's what we'll be doing."
Back in March 2023, the banking crisis in the U.S. made it obvious that something needs to be done in terms of regulation, such as applying stricter capital rules for banks. Higher regulation costs for banks translate into lower profitability as operating expenses increase.
Some may argue that adding regulations now is an unwise move as it adds additional stress, but I disagree with this completely as I consider regulation is too important and is necessary to avert another banking crisis that could spread in the economy and cause turmoil in financial stability. Higher regulatory costs will be a negative factor for all banks in the near-term, but it's a drop in the bucket compared to the cost of the kinds of mistakes made by Silicon Valley Bank and company due to insufficient regulations.
Pathward Financial: Financials are good but revenue growth is slowing
One regional bank stock on my watchlist is Pathward Financial (CASH, Financial), which has announced that it will partner with another financial technology company, Propel, to launch a new credit line targeting consumers that are overlooked by traditional banks. "Creating financial access for individuals who often get overlooked by more traditional lenders by offering the Pathward Line of Credit aligns with our purpose," said Pathward President Anthony Sharett. "We are thrilled to partner with Propel to bring this program to the market as a part of our Banking as a Service offering. Working together, we can provide eligible borrowers with year-round access to credit through a better alternative to high-interest programs."
This announcement is positive news, and the shares of Pathward seem to have momentum, being up 11.24% so far in 2023. Pathward has a GuruFocus momentum rank of 9 out 10. Overall, the GF Score is 84 out of 100.
The stock seems to be modestly undervalued with a GF Value of $53.53, but the revenue growth has slowed down over the past 12 months. It is indicative that during the past 12 months, the revenue per share growth was just 7.10%. In contrast, during the past three years, the average revenue per share growth rate was 12.90%, and during the past five years, it was 17.20%.
Since I consider the regulatory and business risks to be very important, I am worried about the slowing revenue growth. The valuation does not provide enough margin of safety for me to consider the stock attractive now.
