Banks that rely heavily on lending products for revenue have been hit by higher interest rates. But capital markets expect rate cuts in 2024. That could give bullish vibes for regional banks.
It’s not just higher interest rates that have been putting downward pressure on regional banks. A spate of bank failures also shook the confidence in the banking system earlier this year. But brighter prospects are ahead in 2024, with the expectation that the Fed will loosen monetary policy.
“Following bank failures and aggressive interest-rate hikes, regional lenders face headwinds in higher funding costs, muted lending, tougher regulation and weakening credit quality,” reported Bloomberg. “With the rising rate cycle nearing an end, net-interest margins could reach a bottom over the next few quarters, while potential rate cuts in 2024 would ease deposit pressure.”
At the current valuations, such banks could also be offering plenty of future upside for investors. That, once again, will hinge on the pace of rate cuts amid weakening inflation.
“Though valuations reflect uncertainty and weaker earnings profiles, sentiment may be improving if inflation continues to dissipate and longer-term yields retreat,” the report added.
DPST seeks daily investment results equal to 300% of the daily performance of the S&P Regional Banks Select Industry Index. The index is a modified equal-weighted index designed to measure performance of the stocks comprising the S&P Total Market Index that are classified in the GICS regional banks subindustry.
The S&P 500 Regional Banks index reflects the volatility that’s been hitting regional banks this year. The index made a steep drop after the fallout from the bank failures earlier this year. But it has risen over 20% the last three months.
The Bearish Take on Regional Banks
There is optimism heading into 2024. But ratings agency Fitch foresees challenges ahead for regional banks. That’s especially so for banks not big enough to weather the storm of uncertainty in the financial sector. That’s also the case for those too reliant upon commercial loans.
“Regional banks lacking in scale will be disproportionately pressured to reduce cost bases and optimize loan composition,” Fitch noted. That which would “diminish their ratings headroom, leaving larger players relatively well-positioned to continue to gain market share.”
As mentioned, rate cuts will certainly ease pressures on regional banks. But it’s not a viable strategy to simply wait for the Fed.
“What we’re seeing in the market is some banks are proactive in actually selling or planning to sell securities with some hit to capital, just to position themselves better,” said Moody’s managing director Ana Arsov. “But some banks may be just… waiting and just counting that the forward curve is correct and waiting for that rate cut. But hope is not a strategy.”
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