Regional bank earnings likely to be overshadowed by rate cut hopes

Regional bank stocks are breaking out, and they may be able to continue to climb even if second quarter earnings results are modest. The SPDR S & P Regional Bank ETF (KRE) has risen for six straight trading sessions and on Monday closed at its highest level since December. The regional bank ETF’s 12.5% rally in July has coincided with declining bond yields and increased confidence among traders that the Federal Reserve will start cutting interest rates in September. KRE 1Y mountain This regional bank ETF is at its highest level since December. Of course, any rate cuts later this year won’t be reflected in second-quarter results, nor will the lower bond yields that followed last week’s surprisingly cool inflation report. But markets are forward looking, and investors could draw inspiration from the fact that bank stocks outperformed after rates peaked in 1995, the last time the Fed pulled off a “soft landing” in the economy. “Banks stocks rose 54% in 1995 (+34% S & P) on the back of a Fed pause following 250bp in rate hikes,” Bank of America analyst Ebrahim Poonawala said in a July 11 note. “While we recognize that no two periods are the same, the combination of discounted valuations and investor comfort around EPS outlooks coming out of 2Q24 prints could set the stage for a sustained bounce into U.S. elections,” he added. Regional banks have struggled during the post-pandemic rate-hiking cycle, as the rapid rise in rates hurt their core business of borrowing short-term in the form of deposits, which have risen in cost, while making long-term loans. Commercial real estate is also a weak spot for smaller banks compared to their more diversified, larger peers. The group still trades below historical valuations more than a year after the failure of Silicon Valley Bank, according Bank of America said. However, rate cuts should help ease the concerns that have weighed on the sector. “Banks hurt by higher funding costs, and/or perceived commercial real estate (CRE) risks should react positively, We highlight Buy-rated Western Alliance -WAL, Neutral-rated New York Community -NYCB as two banks that could particularly benefit from lower rates,” Poonawala said. At the individual stock level, discussions about loan loss reserves and net interest income could be key for the regional banks, Goldman analyst Ryan Nash said in a July 1 note. “We could be at the peak for reserves (we conservatively model a 2bp increase) and any additions to [loan loss reserve] ratios are likely driven by shrinking balances. We expect the focus to be on 2H [net interest income] guides which should be decent given tailwinds from fixed rate asset re-pricing, some pick-up in loan growth and decelerating increases in deposit costs,” Nash said. Notable regional bank earnings reports this week include Citizens Financial Group on Wednesday, M & T Bank on Thursday and Fifth Third Bancorp on Friday. — CNBC’s Michael Bloom contributed reporting.