U.S. regional bank stocks are under extreme pressure right now. Just look at the SPDR S&P Regional Banking ETF (KRE:US), which tracks an index of smaller U.S. banks and features names such as New York Community Bancorp, Citizens Financial Group, and Huntington Bancshares among its top 10 holdings. Year to date, it is down around 40%.

So, what’s going on with the regional banks? And how have US politicians been trading this area of the market?

The regional bank meltdown

There are a number of reasons regional bank stocks are getting hammered right now. They're all related to higher interest rates, however.

Since March last year, the US Federal Reserve has increased interest rates from near zero to 5-5.25% – a 16-year high. And this has created all kinds of challenges for smaller banks.

For a start, the higher rates have lowered the value of fixed-income securities on banks’ balance sheets. In some cases, this has had a disastrous impact. Silicon Valley Bank (SVB) is a good example here. Due to large fixed-income losses, it was forced to raise capital. This led to a run on the bank, which in turn, led to it becoming insolvent.

Secondly, higher rates have led to higher deposit costs, putting a strain on net interest margin (NIM). It’s worth noting here that after the collapse of SVB, smaller banks have needed to pay high rates to depositors to prevent them from moving their capital to larger, safer institutions. So, profits are getting squeezed. "Regional banks are likely to experience higher funding costs, as the industry gets more aggressive on deposit retention,” wrote Ebrahim Poonawala, Head of North American Banks Research at BofA Global Research recently.

Stricter regulation designed to strengthen the US banking system is also likely to squeeze profits. During the Trump Administration, US regulators changed rules to weaken a range of capital requirements for regional banks. However, the Biden Administration wants to reverse these changes and tighten lending criteria. “We expect the higher regulatory burden will be a drag on profitability,” wrote analysts at Franklin Templeton in a recent research note.

Finally, investors are concerned that higher interest rates will lead to loan defaults. Regional banks lend money to individuals, families, and businesses across the US, and right now, many borrowers are under pressure. Some analysts are worried about risks to the banking sector lurking in the commercial real estate space, which has been hit by a fall in demand for office space due to the rise of remote work.

Overall, there is a lot of uncertainty, and investors have lost confidence in the industry. "Confidence in a financial institution is built over decades and destroyed in days. As each domino falls, the next weakest bank begins to wobble,” tweeted billionaire investor Bill Ackman recently.

The casualties

Already, we have seen several casualties in the regional banking space. In March, SVB, Silvergate, and Signature Bank all went under. More recently, First Republic collapsed.

Investors are concerned that other banks could go the same way. Two banks that have seen their share prices tank recently on the back of liquidity concerns include Western Alliance, an Arizona-based bank with total deposits of around $48.8 billion, and PacWest, an LA-based commercial bank with over $41 billion in assets.

How politicians have been trading the regional banks

Looking at Capitol Trades’ data, it’s interesting to see that politicians were selling shares in this area of the market late last year.

The charts below show that there was a spike in selling activity in November. They also show that for the six-month period to the end of March, sales of smaller banking stocks far outweighed sales of larger banking stocks.

As for the regional banks with the most trading activity recently, First Republic saw a lot of activity before it went under. In March, it saw sales from a number of politicians including Democrats Lois Frankel, Daniel Goldman, and Earl Blumenauer, and Republican John Curtis.

Seacoast Banking Corp of Florida has also seen elevated selling activity. Between late January and late March, its shares were sold by Democrats Josh Gottheimer, Jared Moskowitz, and Daniel Goldman.

Ally Financial is another banking stock that has registered multiple sales recently. In March, the stock was sold by both Republican Michael McCaul and Democrat Daniel Goldman.

Going forward, we will continue to monitor politicians’ trading activity in this area of the market. Looking at recent developments, the crisis in the US banking sector is far from over.