The U.S. regional banking sector is making a strong comeback, signaling resilience and potential for future growth. JPMorgan analyst Anthony Elian, in a note on the sector’s third-quarter earnings season, highlights a wave of positive developments.
Several mid- and small-cap banks delivered stronger-than-expected earnings, surpassing analysts’ predictions. This outperformance is largely attributed to robust net interest margins (NIM) and net interest income (NII), indicating a healthy financial foundation for the sector.
Further bolstering the optimistic outlook is the expectation of gradual rate cuts by the Federal Reserve. The de-inversion of the yield curve, easing credit quality concerns, and potential for capital returns are all contributing factors to the positive sentiment surrounding regional banks.
One week into the earnings season, seven regional banks within JPMorgan’s coverage universe have reported results, with five exceeding core earnings-per-share (EPS) estimates. This trend has translated into strong stock performance, with regional bank stocks, as represented by the SPDR Regional Banking ETF (KRE), outperforming the broader market, as measured by the SPDR S&P 500 ETF Trust (SPY), so far this month.
“With more beats than misses and 4Q24 outlooks generally trending better than prior consensus expectations, regional banks are outperforming through earnings season so far,” Elian noted.
Beyond the strong earnings, several key trends emerged during the third quarter. Average deposits increased at a 7% annualized rate, while average loans grew by 2% annually. On a period-end basis, these figures climbed even higher, with deposits rising at an 11% annualized pace and loans increasing by 3% annually. Importantly, NII expanded at a robust 12% annualized rate.
While some concerns remain regarding office loans, overall credit quality has remained stable. However, a few banks reported increases in non-performing assets (NPAs) related to office loans.
Looking ahead, the fourth quarter outlook remains positive. Many banks are projecting modest growth across key metrics such as loan growth, NII, and fee income, while expense growth is anticipated to remain controlled.
Despite potential near-term headwinds, most banks in Elian’s coverage universe are optimistic about the NII trajectory into 2025, particularly as the Federal Reserve is expected to reduce interest rates further. “With the Fed continuing to reduce the funds rate, this outlook should be further supported by an eventual rebound in commercial loan demand across the industry,” Elian said.
Regional banks are currently trading below historical valuations. JPMorgan’s coverage universe is priced at 1.3x 2025 estimated tangible book value (TBV), compared to the historical range of 1.8x to 2.0x. This disparity indicates substantial upside potential for a re-rating of the sector, especially considering investors remain underweight regional bank stocks.
“Expect the sector to re-rate higher as investors recognize their improved financial health and earnings potential,” Elian noted.
Elian’s top picks for the sector include First Citizens BancShares Inc. (FCNCA), Western Alliance Bancorp. (WAL), and Pinnacle Financial Partners Inc. (PNFP), all of which are strategically positioned to capitalize on favorable market dynamics and potential earnings growth into 2025.
The positive momentum in the regional banking sector, driven by strong earnings, a favorable regulatory environment, and investor optimism, suggests that this segment of the financial market is poised for continued growth and outperformance in the coming months and years.