U.S. bank stocks surged on Thursday following the Federal Reserve's decision to cut interest rates by 50 basis points, boosting optimism about lower deposit costs and easing pressure on borrowers.
Banks have been preparing for potential defaults by setting aside billions as a buffer, particularly in their commercial real estate (CRE) portfolios, where the office space market has been hit hard by reduced demand.
"For banks, especially those holding mortgages and auto loans, this cut could provide short-term benefits to interest rate spreads," said Charlie Wise, Senior Vice President and Head of Global Research and Consulting at TransUnion.
Wells Fargo shares rose 3%, while JPMorgan Chase, the largest U.S. bank by assets and a key indicator for the sector, was up 1%. Citigroup and Bank of America saw gains of 2.6% and 2.3%, respectively. Meanwhile, Goldman Sachs climbed 3%, and Morgan Stanley rose by 1.3%.
Refinancing Opportunity
Major banks followed the Fed's lead by lowering their prime lending rates on Wednesday. However, most mortgages and auto loans are fixed-rate, meaning these institutions will continue to benefit from higher yields on existing debt.
Borrowers seeking immediate relief may look to refinance, potentially negotiating better terms and reducing the risk of defaults. "The Fed’s cut eases uncertainty surrounding borrowing costs and the broader economy," noted J.P. Morgan analyst Steven Alexopoulos. "We anticipate that lower rates will stimulate commercial demand for loans."
Regional banks, which have greater exposure to the CRE market, are expected to gain more from rate cuts compared to their larger counterparts. Shares of regional banks like Valley National, Banc of California, KeyCorp, and Western Alliance all jumped around 3.8%.
"The positive reaction from bank stocks is logical, as a 50 basis-point cut helps mitigate concerns about high credit risk," said analysts at Jefferies. Allen Tischler, Senior Vice President of Moody's Financial Institutions Group, added that the rate cut is "credit-positive for asset quality, as it makes debt payments more affordable for borrowers with variable-rate loans."
However, the broader economic environment remains precarious. While investors anticipate further easing by the Fed, some are questioning whether the central bank may be reacting too slowly. Earlier in 2023, several major banks collapsed, partly due to higher rates that inflated unrealized losses in their investment portfolios.
As of the latest close, the KBW Regional Banking Index is up 4.4% year-to-date, compared to an 18% rise in the S&P 500. The S&P 500 Banks Index, tracking large-cap banks, has gained 17.5% during the same period.
Jefferies analysts added, "This rate cut raises questions about the underlying economy and whether the Fed is more concerned about a deeper economic slowdown than it has previously signaled."
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