What do earnings tell us about regional bank performance?

Regional Bank Performance & Outlook - Analysis of Recent Trends

Key Concepts:

• Commercial Real Estate (CRE): Property used for business activities, including office buildings, retail spaces, and industrial facilities. A key area of concern for regional banks due to potential loan defaults.
• Net Interest Income (NII): The difference between the revenue a bank generates from its interest-bearing assets and the expenses it pays out on its interest-bearing liabilities. A primary driver of bank profitability.
• Non-Performing Loans (NPLs) / Credit Quality: Loans where the borrower is not making scheduled payments. A key indicator of bank health.
• Tariffs: Taxes imposed on imported or exported goods, impacting business investment and loan demand.
• NDFI (Non-Deliverable Forwards): Financial contracts used to hedge currency risk, particularly relevant for banks with international exposure.
• AUM (Assets Under Management): The total market value of the financial assets that a financial institution manages on behalf of its clients.
• Asset-Liability Mismatch: A situation where a bank’s assets and liabilities have different maturities, creating risk if interest rates change.
• Uninsured Deposits: Deposits exceeding the FDIC insurance limit ($250,000), posing a flight risk during times of bank instability.

I. The Aftermath of the 2023 Banking Crisis & Initial Investor Hesitation

The failure of three mid-sized US regional banks in March 2023 triggered a significant downturn in the sector and prompted intervention to prevent a wider collapse. Investor confidence remained shaken for several years following the crisis. Initial concerns centered around commercial real estate (CRE) exposure, exemplified by the significant drawdown experienced by Flagstar. From 2022-2024, many regional banks experienced earnings contraction, with sentiment only beginning to improve in 2025, leading to modest valuation gains. The initial shock lingered, impacting investment decisions.

II. 2024 Performance: A Mixed Bag

Regional banks, on average, saw a 7% increase in their stock price in 2024, but this was tempered by several headwinds. The implementation of tariffs in April negatively impacted loan growth, as small businesses delayed investment decisions due to uncertainty. Bankruptcies, specifically First Brands, raised concerns about potential contagion, leading to sell-offs, though these concerns proved largely isolated to the third quarter. Credit quality issues did not broadly spread into the fourth quarter.

III. Current Earnings Trends & Improving Credit Quality (2025)

Current earnings reports indicate improving credit quality as a key positive trend for regional banks. Commercial real estate losses are decreasing, and forward indicators suggest continued improvement. Management guidance generally points towards enhanced credit quality. Loan growth, initially weak due to tariffs, began to accelerate towards the end of 2024 and is expected to continue, driven by increasing business optimism. Recession odds have fallen from nearly 30% to the low 20s, further bolstering confidence. Net interest income is benefiting from this loan growth.

IV. Regional Bank Advantage: Margin Expansion

Regional banks possess a unique advantage over larger institutions due to their prior underperformance. This lower baseline makes it easier for them to demonstrate improvement. Specifically, deposit costs, which surged for regional banks following the Silicon Valley Bank failure, are now decreasing with falling interest rates. This benefits regional banks more significantly than larger banks, which did not face the same deposit pressure, leading to potential margin expansion.

V. Bank-Specific Analysis: Top Picks

• East West Bankcorp: Identified as a top pick, despite historical criticism. The bank demonstrated resilience during the 2023 crisis, with deposits not falling unlike many peers. This is attributed to its strong customer base among Asian-Americans, who exhibit greater loyalty. Despite concerns related to exposure to Asian markets (particularly China) due to the tariff sell-off in April, actual exposure to loans outside the US is minimal. Charge-offs improved, and the bank avoided issues related to NDFI losses. East West Bankcorp consistently outperforms the industry in deposit, loan, revenue, and earnings growth, yet remains undervalued due to perceived risks associated with its Asian-American customer base.
• Citizens Financial Group: Previously viewed as neutral, Citizens Financial Group has become more bullish due to the acquisition of wealth managers from the failed First Republic Bank. While seemingly opportunistic, this acquisition is viewed positively because Citizens avoids the issues that plagued First Republic – a large volume of uninsured deposits and asset-liability mismatch. The acquired wealth management business is driving significant loan and deposit growth, increasing AUM, and potentially expanding valuation multiples. Loan growth, previously a weakness, is accelerating due to the private bank and improving economic conditions.

VI. Logical Connections & Overall Perspective

The analysis demonstrates a clear progression from the initial shock of the 2023 banking crisis to a more optimistic outlook for regional banks in 2025. The initial investor hesitancy, driven by CRE concerns and the fallout from Silicon Valley Bank, has gradually subsided as credit quality improves, loan growth accelerates, and macroeconomic conditions stabilize. The bank-specific analysis highlights the importance of identifying institutions with unique competitive advantages and strong fundamentals. The narrative emphasizes that while challenges remain, regional banks are positioned to benefit from improving economic conditions and their own internal strengths.

VII. Notable Quote:

“...the real takeaway is credit quality because that has been a concern for regional banks for a while now, and that has been improving.” – Alexander Yokum, Senior Vice President of Equity Research at CFR.

Conclusion:

The regional banking sector is showing signs of recovery and potential growth. Improving credit quality, accelerating loan growth, and a unique advantage in margin expansion position these banks for positive performance. Strategic acquisitions, like Citizens Financial Group’s purchase of wealth management assets, can create competitive niches and drive further growth. While caution remains, particularly regarding lingering concerns about specific banks like East West Bankcorp, the overall outlook for the sector is increasingly favorable.