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Regional Bank Stocks Rebound on Expected Pause in Rate Hikes

Yesterday, U.S. regional bank stocks staged a major rally, with banking indexes regaining some footing despite the reports of stringent capital requirements. Financials were the day’s top-performing sector, with S&P 500 Financials rising 1.3%.

Likewise, the KBW Regional Banking Index almost hit a seven-week high to jump 5.4%. Further, the S&P Banks Select Industry Index was up 4.4%.

Talking about individual stocks, big names, including Bank of America BAC, Citigroup C, Goldman Sachs, Morgan Stanley and Wells Fargo WFC, rose between 1.5% and 3%. Regional lenders like PacWest Bancorp, Western Alliance, Zions Bancorp, Comerica CMA, Truist Financial and KeyCorp KEY performed even better, increasing between 4% and 8.5%.

The primary reason for bullish investor sentiments toward regional banks seems to be an expected pause in interest rate hikes. The Federal Reserve officials will be holding a two-day FOMC meeting later this month, and market participants are forecasting no change in rates this time.

Per the CME FedWatch tool, currently, there is nearly an 80% chance that the central bank will keep interest rates unchanged. Since last year, the Fed has been ultra-aggressive in raising interest rates to curb ‘sticky’ inflation. At present, the Fed fund rates stand in the range of 5-5.25% (the highest level in 15 years).

While banks are known to benefit from higher rates, this time it has turned out to be a bane. Faster rate hikes have placed banks in a disadvantageous situation. The loan demand is gradually waning, and funding costs are increasing. This has put pressure on banks’ net interest margin (NIM).

Though banks like Bank of America, Wells Fargo, Citigroup, Comerica and Truist Financial witnessed expansion in NIM on a year-over-year basis in the first quarter, they are now projecting not much further expansion in the metric in the coming period. Hence, banks’ net interest income (a major revenue source) is also now expected to rise modestly.

Further, the faster rate hike triggered a regional banking crisis and was the primary reason for the collapse and failure of three major regional banks since March 2023. A host of issues, including potential recession, slowing loan demand, rising funding costs and a high level of fixed-rate mortgage and commercial real estate loans, as well as uninsured deposits in the balance sheet, made the situation difficult for regional banks.

Huge exposure to uninsured deposits and asset-liability mismatches are bigger concerns for several banks, including Comerica and KeyCorp. The banks witnessed heavy deposit outflows following the collapse of Signature Bank and Silicon Valley Bank in March.

Nonetheless, the situation has stabilized since then, and investor stance is turning optimistic toward regional bank stocks. However, strong inflation reading and a tight job market indicating that the economy remains solid are likely to lead the Fed to keep options open about future interest rate hikes.

At present, BAC, C, WFC, CMA and KEY each carry a Zacks Rank #3 (Hold). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.

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