HSBC Private Bank sets out why investors should learn to love US regional banks again after this sector has been out of favor since 2008.

With the US housing market back at levels not seen since pre-global financial crisis, the case for increased portfolio exposure to US regional banks is even stronger, while specific areas of the US banking sector could be teetering on a "significant turnaround," says Dean Turner of HSBC Private Bank.

"Capitalization has already improved and although regulatory risks remain, we think this should be more of a challenge for systematically important investment banks than for US regional banks," Turner, investment strategist, said in an investment note. He highlighted how the "dramatic underperformance" - amounting to about 25 per cent relative to the S&P 500 since 2007 - should now start to reverse.

While headwinds facing the banking industry have not vanished completely, more stringent capital requirements, along with tougher regulations and deleveraging, are likely to be topics surrounding the industry for some time to come. “However, none of this is new news, and we think that share prices generally more than reflect these concerns,” Turner said.

Housing recovery “likely to develop into something more sustainable”

HSBC believes there are many housing indicators which point to recovery. Aside from the fact that the percentage change of median prices for existing home sales is now at 10 per cent (the worst recording was in 2009, at about -17 per cent), the stock of unsold homes has fallen back to more reasonable levels, whilst the low interest rate environment has improved affordability. Meanwhile, quantitative easing programs have been successful in lowering mortgage rates to a "historically low level" of 3.38 per cent for 30-year loans.

That house prices are no longer falling should also boost investor confidence. Additionally, steady or rising house prices should enable some release of previous provisions against expected losses. “With stabilizing or rising house prices, we anticipate better tax revenues for municipalities and, accordingly, expect stronger local employment trends and spending,” Turner explained, adding that improvements are also forecast in municipal finance, benefiting regional banks through improved asset quality.

According to HSBC, an attractive way to participate in this recovery is via the US regional banks, as shares of home builders only give investors exposure to the new homes industry. While that sector is robust, it is it unlikely to capture the full benefits of the recovery in house prices (unlike lenders). Finally, valuations and estimates assigned to regional banks do not, the bank said, seem to reflect the potential recovery in earnings.