Bank Sector – Q4 2023 Commentary

For 4Q, the Bank Sector Strategy returned 22.45% (gross of fees) and 22.15% (net of fees) vs. the Russell 2000® Value Index Bank Subsector benchmark of 28.63%.  The portfolio lagged as banks with higher short interest, many which we believe may be permanently impaired, outperformed.  For the full year 2023, the Bank Sector Strategy returned 4.79% (gross of fees) and 3.75% (net of fees) vs. the Russell 2000® Value Index Bank Subsector benchmark of -0.63%.  Additional performance information is included in the table below.

Data as of 12/31/2023

The fourth quarter of 2023 will be remembered most for the aforementioned “Fed Pivot” on December 13th which caught many by surprise.  This was because when the Fed Chairman last spoke in early December, the message was still consistent with one more rate hike and lowering rates had not even been considered at that point.  Data that was released between early December and December 13th seemed to bolster the “higher for longer” argument before the message changed drastically on the 13th.

While the timing of interest rate cuts is difficult to determine, after the “pivot” it now seems to be a matter of when, not if, which in our opinion would help create a floor on real estate values and foster in a softer landing for the economy both of which would be positives for bank stocks.  Since this shift by the Fed Chairman, we have added a handful of liability sensitive banks to the portfolio which would benefit more than other banks when interest rates do decline, and we believe the portfolio is well positioned going into 2024.  We do expect credit quality to continue to normalize; however, since most banks adopted the CECL (current expected credit losses) loan loss methodology in 2020, the industry appears well positioned to handle this.

Finally, after speaking with several bank management teams throughout 4Q, many believe that lower interest rates (which will lessen the negative capital impact of accumulated other comprehensive income (AOCI) on capital and tangible book value for banks) could also serve to be a catalyst for bank M&A as well in 2024.  In addition, while this wouldn’t possibly happen until toward the end of the year, a potential change in political administration may also serve as a potential catalyst for the bank group as a Republican President would likely lead to a certain amount of banking regulations being relaxed over the next Presidential term as we witnessed during the last Republican Presidential term.

Sincerely,

Brian Hagler

Portfolio Manager

Ithiel Turrado, CFA®

Research Analyst

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Although the statements of fact and data in this report have been obtained from, and are based upon, sources that the Firm believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the Firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. A complete list of all securities recommended by KCM in the preceding year, a fully compliant GIPS composite report, and the list of composite descriptions are available upon request from KCM at 10829 Olive Blvd., Suite 100. St. Louis, MO, 63141.

Bank Sector Strategy Composite is invested in securities of value and growth companies that have a market capitalization ranging from microcap to small cap, generally reflective of the Russell 2000® Value Index Bank Subsector. The U.S. Dollar is the currency used to express performance.

Composite specific data provided within this presentation has been calculated from accounts that are discretionary as defined in this paragraph. The assets shown are derived only from discretionary accounts. Non-discretionary accounts, as defined by KCM, are accounts that are not included in the composite due to one or any combination of the following criteria: there were significant cash inflows or outflows within the account; the account’s asset level did not meet the minimum requirement to remain in the composite; the account assets are managed by others using our non-discretionary model. The temporary removal of such an account occurs at the beginning of the month and the account re-enters the composite the month after the criteria has been met.

Performance returns are presented gross and net of investment advisory fees and include the reinvestment of all income. Gross of fee returns reflect the deduction of transaction costs and custodian fees but do not reflect the deduction of investment advisory fees. Net of fee performance is calculated using gross returns less the actual applicable annual management fee applied monthly. Past performance is not indicative of future results. A client’s return will be reduced by the advisory fees as described in Form ADV Part 2A and other expenses incurred by the account. For example, an annual advisory fee of 1% compounded quarterly over 10 years will reduce a gross 14.44% annual return to a net 13.32% annual return. Form ADV Part 2A is available upon request.

The performance figures reported herein are unaudited, may be based upon information obtained via electronic data sources (”feeds”) and may be subject to change. Data feeds from many of KCM clients’ selected custodians are obtained through third party sources, and are used to compare custodial data to KCM’s client account records as frequently as daily. Monthly, KCM reviews clients’ account holdings along with cash and share quantities against the custodial statements. In some instances, variances may exist between final audited custodial information and the information KCM obtains via such data feeds. Generally, any such variances are researched and reconciled within thirty days of the period end.

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Sector Weightings are subject to change at any time.  Sectors are based on the Global Industry Classification Standard (“GICS”) classification scheme and are measured as a percentage of the total composite in terms of asset value as of the date indicated above.  Individual client portfolios may be different based on variations in security purchase price and date, and individual client restrictions. 

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Allocations to various assets classes change over time and deviate from any stated or targeted percentages of a total portfolio as a result of market conditions and reallocation decisions. Therefore, nothing herein reflects a static portfolio allocation that will remain the same or match stated target allocations of asset classes.

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The Russell 2000® Value Index Bank Subsector measures the performance of micro- to small-cap value segment of the U.S. equity universe. It includes those Russell 2000® companies with lower price-to-book ratios and lower forecasted growth values. The Russell 2000® Value Index Bank Subsector is constructed to provide a comprehensive and unbiased barometer for the micro-cap and small-cap value segment. The Index is completely reconstituted annually to ensure larger stocks do not distort the performance and characteristics of the true small-cap opportunity set and that the represented companies continue to reflect value characteristics. The investment portfolios underlying the Index are different from the investments in the portfolios managed by the Firm. The Russell 2000® Value Index Bank Subsector defined by FTSE Russell using the Industry Classification Benchmark (ICB) standard. ICB is a globally recognized standard, operated and managed by FTSE Russell for categorizing companies and securities using a detailed and comprehensive structure for sector and industry analysis, facilitating the comparison of companies across four levels of classification and national boundaries. The classification system allocates companies to the Subsector whose definition closely describes the nature of its business as determined from the source of its revenue or the source of the majority of its revenue where available. FTSE Russell is responsible for maintaining ICB, and for the classification of all companies within ICB.

The Russell 2000® Value Index Bank Subsector is used as the benchmark. The Index is unmanaged and represents total returns including reinvestment of dividends. The benchmark is used for comparative purposes only and generally reflects the comparable risk or investment style of the Firm’s strategy. The investment portfolios underlying the Index are different from the investments I the portfolios managed by the Firm. Certain accounts may also use other benchmarks not listed in the GIPS composite report. The Verification and Performance Examination Report does not cover the benchmark returns included in the GIPS composite report.  Investors cannot invest directly in an Index.