Higher rates raising ‘downside risks’ for regional banks, warns Bank of America

Published Wed, Feb 14 20241:16 PM EST

The danger of higher rates for longer following the latest hot inflation reading raises the "downside risk" for regional banks, according to Bank of America. Rate cut expectations moved out to later in the year after a hotter-than-expected January consumer price index raised concern that the Federal Reserve's road to its 2% inflation target could be a bumpy one. According to the CME FedWatch Tool , markets are now assigning a greater chance of an easing cycle starting in May or June, instead of in March. At the same time, the 10-year Treasury yield topped 4.3% on Tuesday, a level it last reached in December. It eased slightly on Wedneaday to 4.25%. US10Y 1Y mountain U.S. 10-Year Treasury For regional banks, a move higher in bond yields is especially risky as institutions would have to mark losses in their Treasury holdings, an event that led to Silicon Valley Bank going under last March. "Fewer and later Fed rate cuts pose downside risk to bank stocks," analyst Ebrahim Poonawala wrote in a Tuesday note. "We are especially concerned about the failure of the broader market to project the trajectory of interest rates – a consistent theme since the Fed began raising interest rates in March 2022." "We worry about the risk from no rate cuts in 2024 and a far more elevated level of interest rates across the UST yield curve," Poonawala added. The SPDR S & P Regional Banking ETF (KRE) ended Tuesday's session down by 4.2%, and has dropped more than 10% this year. KRE YTD mountain SPDR S & P Regional Banking ETF "Fundamentally it has the potential to lead to a worse-than-expected credit cycle, squeeze net interest margins (= downside risk to EPS outlooks), while pressuring capital levels due to [mark-to-market] losses on bonds," Poonawala wrote. Net interest margin is the difference between the interest banks earn on loans and pay on deposits. Meanwhile, mark-to-market losses on bonds are generated when the current value of an asset is lower than what the institution paid to acquire them. Instead, the analyst said it prefers larger-cap banks with lower commercial real estate exposure such as JPMorgan , Goldman Sachs and BNY Mellon . In the regional sector, the firm said it prefers Truist , U.S. Bancorp and First Bancorp (Puerto Rico) , among others. — CNBC's Michael Bloom contributed to this report.