Investors are loading up on protection against a fresh round of financial turmoil in US regional bank stocks as lenders prepare to reveal how badly their earnings have been squeezed by the troubles that took down Silicon Valley Bank.

Regional bank share prices have stabilised since SVB’s collapse sparked a massive mid-March slide, but traders are buying record amounts of options tied to midsized lenders that had some of the highest volatility, according to Bloomberg data. Several banks that were badly hit in the recent volatility — including Citizens Financial, Charles Schwab and Keybank — have seen options interest hit record levels, while many more are at multiyear highs.

Pricing of the contracts suggests investors expect stock swings for some banks to be up to three times normal levels, according to analysis by RBC Capital Markets.

The interest in lenders including Citizens Financial and KeyBank, as well as Charles Schwab, an investment group with a banking licence, reflects the trouble facing midsized lenders. They have long played an outsized role in the US economy but face a diminished profit outlook, deposit outflows and tighter regulation that could test their ability to thrive.

Analysts at Morgan Stanley recently cut earnings estimates for regional banks by 20 per cent this year and nearly 30 per cent for 2024.

“The profitability of the sector has gotten a lot harder in the past month,” said Chris McGratty, who follows regional banks for KBW and expects the recent crisis will result in more mergers. “Bank boards are going to have to discuss whether it still makes sense to be an independent company.”

Options investors are pricing in share price swings of more than 10 per cent on two of the first regional banks to report results later this month: Utah’s Zions Bancorp and Texas-based Comerica.

“A lot of volatility is expected and that is being baked into the market early,” said Amy Wu Silverman, equity derivatives strategist at RBC Capital Markets. “A fair number of clients are thinking about earnings season as a possible inflection point” which could lead to large gains or losses depending on the banks’ reported earnings.

The US is home to about 4,400 banks, but the concern sparked by SVB’s collapse is focused on roughly 100 lenders that fall just below the country’s top 20 banks including as JPMorgan Chase and Bank of America.

These midsized lenders have between $10bn and $150bn in assets and collectively make about one-third of all US loans, including what a 2015 Harvard study called a “disproportionately large” share of commercial lending, particularly to small businesses.

Many banks started this year nursing paper losses on their bond investments because of rising interest rates. The collapse of SVB, Signature and Silvergate caused wider ructions among customers and investors, speeding up deposit outflows and sending the KBW regional banking index down 20 per cent in 10 days.

Emergency measures from the US Federal Reserve and the Federal Deposit Insurance Corporation and a decision by the nation’s largest lenders to deposit $30bn into one of the hardest hit banks, First Republic, stemmed the immediate slide. But analysts worry that the sector will limp along for years to come.

The regional banks “are in a really difficult position”, said Blake Gwinn, head of rates strategy at RBC.

Unlike large banks which routinely tap wholesale markets, regional and community banks generally fund their lending by taking in deposits. This time last year, smaller US-based commercial banks collectively held $5.3tn in core deposits, backing $4.6tn in loans and hard-to-sell investments, according to the Fed. The gap meant the banks had a buffer of $700bn in cash or assets to sell if depositors wanted their money back.

That buffer is gone, according to data the central bank released last week. Regional and community lenders had $260bn more in loans and hard-to-sell investments than they did in deposits. As customers spent or moved cash accumulated during the pandemic, smaller banks had collective outflows of $420bn in core deposits since the middle of last year, including $250bn in the past month.

Regional lenders have turned to government-backed entities, borrowing about $300bn from the Fed and the Federal Home Loan Bank.

To remain healthy, the lenders must woo back customers from money market funds, which currently pay more than 4 per cent annually versus about 0.5 per cent for most bank savings accounts, said Jim Bianco, a macro strategist at Bianco Research. But that would cut sharply into profitability.

“The common wisdom was that you are more likely to get divorced than leave your bank,” Bianco said. “The rational thing for people to do these days is not to keep their money in a bank.”

Regional bank profits will be further squeezed by plans to reimpose more stringent rules and regulations in the aftermath of SVB’s collapse, analysts predict. President Joe Biden has called for a reversal of 2018 changes that reduced the oversight of banks with $50bn to $250bn in assets.

“Part of regulation is judging the balance between safety and soundness on the one hand and the cost of those regulations and the costs of that supervision to see the ultimate goal, which is to have a financial system that really does function and helps the economy,” said Richard Berner, who previously ran the US Office of Financial Research, a bureau that reports to the Treasury.

Regulators should force banks to raise more capital to make sure they can continue to “lend freely going forward”, said Jonathan Parker, a professor of finance at the Massachusetts Institute of Technology, even though current shareholders “will find the rate at which they can raise capital unfavourable”.

Even though tougher capital and liquidity provisions would raise the cost of doing business at regional banks, Donald Kohn, a former vice-chair of the Fed, said the changes could make them more attractive to investors and customers over the long-term. “It might reassure people they are safer and more viable over time,” he said.

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