When a legendary investor makes a big bet, it’s wise to pay attention…
That’s exactly what the “Bond King” Bill Gross just did with regional banks.
Gross co-founded PIMCO in the early 1970s. And he ran the investment firm’s Total Return Fund for more than four decades before leaving the company in 2014.
I’ve followed Gross my whole career. I respect his knowledge when it comes to bonds.
And when Gross moves into a subsector – like regional banks – it makes big moves. (My colleague Vic Lederman wrote about the industry’s recent trend change last Wednesday.)
But when I saw the latest bet from Gross, my first thought was…
Why is a former bond-fund manager making a bold call on regional banks? And why should anyone care?
Today, I’ll dig deeper into those two questions…
As you’ll see, it’s not really about the regional banks themselves. It’s more about what’s on their balance sheets. And more importantly, you’ll find out why you should care…
In short, Gross isn’t likely looking at the business of banking. Rather, he’s probably focused on the bonds that the regional banks hold…
Banks hold a large amount of bonds on their balance sheets. It’s a regulatory requirement.
And bond prices have rallied recently. For example, the iShares 20+ Year Treasury Bond Fund (TLT) is up around 6% over the past few weeks. That’s a big move for a bond fund.
So the banks’ book value is likely improving because of their investments in that area.
That’s good news for these banks in the short term. And it’s probably a big reason why the Power Gauge recently flipped to “bullish” on the SPDR S&P Regional Banking Fund (KRE).
But as Vic said last week, we’re on the early side of this trend change. And although Gross is making a bet on regional banks right now… I wouldn’t rush to follow in his footsteps.
You see, regional banks are heavily leveraged against commercial real estate (“CRE”). In fact, they hold 70% of all the CRE loans on the books today.
But many major U.S. banks are cutting their exposure to CRE…
For example, Morgan Stanley (MS) took a more than $130 million loss instead of riding out the storm. And Goldman Sachs (GS) recently lowered its exposure to CRE by 50%.
In addition, last month, Bank of America (BAC) said its loans that are at least 90 days past due rose from $4.3 billion in the second quarter to nearly $5 billion this quarter. And the bank blamed most of that increase on the trouble in the CRE space.
PNC Financial Services’ (PNC) CRE-related delinquencies have also surged. They’ve more than doubled from $350 million in the second quarter to $723 million in the third quarter.
The list of banks dealing with CRE problems is long. And the message is simple…
CRE isn’t out of the woods yet. And if all these large U.S. banks are taking losses and holding bad loans, what do you think the regional banks are up against?
Unfortunately for investors, it’s the same story.
Look, the bond market isn’t rocket science. As interest rates drop, the value of bonds increases.
That gives banks more room to lend because the value of their bond holdings is higher. But given the lengthy period of higher rates we’ve endured, they’re still in a hole today…
The banks’ unrealized losses might not be as bad as they were. But it doesn’t mean they’ve disappeared.
And don’t forget…
Even if the banks’ capital available for lending expands, someone needs to be willing to borrow the money to make things work. And as the economy slows, less borrowing occurs.
In the end, it’s great to see a rally in a subsector like regional banking. But be careful…
You don’t want to get stuck in a “value trap.”
Bill Gross is a great bond-portfolio manager.
But what Gross does with his money is his business. It doesn’t mean you need to do it, too.