Small bank index suggests recovery is elusive

Many banks that got funding from the government have seen their shares soar, while smaller, regional banks have not.

That's a sign that investors believe the smaller banks are less well placed to participate in, and contribute to, the economic recovery, said the chairman of Coxe Advisors LLC in Chicago, who advises clients of the BMO Financial Group.

Coxe said the economy will only grow when banks, and especially the smaller banks that are more likely to make loans to Main Street than Wall Street, lend more freely.

But regional and community banks are struggling in the wake of the global financial crisis and bank credit to businesses and consumers is contracting, he said in a report released this week.

"The thousands of regional U.S. banks on which an economic recovery depends have not participated in the sudden explosion of trading profits" of the biggest five U.S. banks, he said.

The state aid granted to large banks during the financial crisis has convinced investors the government will step in again in future to save the behemoths if needed. That has helped pull share prices back up from the 12-year lows hit in March.

By contrast, as more commercial real estate loans turn bad in the still-feeble economy, regional and community banks are struggling.

A key gauge of the gulf between big banks and smaller lenders is the KBW Regional Bank Index exchange traded fund . The ETF's recovery has lagged the rebound in shares of the biggest five U.S. banks, said Coxe.

"There will not be the kind of sustained U.S. economic recovery that will drive a sustained U.S. bull market until the shares of the Main Street (KRE) banks begin to outperform" both those of the biggest five banks and the S&P 500 index <.SPX>, he said.

The health of the economy depends on regional banks, which are failing in droves, draining the resources of the Federal Deposit Insurance Corp.'s fund that insures bank deposits, he said.

Since confidence in the U.S. financial system and bank stocks hit a nadir in March, the KBW Regional Bank Index has risen about 42 percent, while the S&P 500 stock index has climbed 64 percent.

Investor confidence in financial institutions that are now perceived as enjoying government support has propelled those stocks far higher than those of smaller and regional banks, said Coxe.

A broad exchange traded fund which includes the biggest banks and financial institutions in the S&P 500 has jumped by 136 percent since March, far outstripping the rise in the regional bank index.

For graph, see:

http://graphics.thomsonreuters.com/119/US_BANKS1109.gif

Yet eventually, the trillions of dollars of taxpayers money used to support financial institutions, homeowners and securities markets will run out, leaving the economy's fortunes once again dependent on private sector lending.

"The relatively obscure KRE is, we believe, the most reliable indicator of whether the panoply of political programs is truly kick-starting a sustainable U.S. recovery -- and whether the optimism of U.S. equity investors is justified," said Coxe.

So far, little of the government money given to big banks has reached those who need it most.

"Access to credit remains strained for borrowers who are particularly dependent on banks, such as households and small businesses," Federal Reserve Chairman Ben Bernanke said on Monday.