Why regional banks are set to benefit from easing interest rates

Christopher McGratty, head of US bank research at KBW, a Stifel Company, joins Market Domination to discuss how the Federal Reserve's rate easing cycle will impact regional banks and lays out some of his top picks in the sector. "We're figuring this out as we go. The 50-basis-point cut last week was, as Powell said, a good, strong start," McGratty tells Yahoo Finance. He explains that to get to a terminal rate of 3%, the Federal Reserve will likely initiate 25-basis-point cuts for the rest of 2024 and throughout 2025. He believes that easing rates will be bullish for regional banks, explaining, "Over the last 18 months, the largest banks have significantly outperformed the regional, the smaller, banks to the point of 2,000 basis points. And so the reason for that is their balance sheets and their income statements are less reliant on interest rates than the small banks. So what you've seen over the last month or two is a little bit of a catch-up trade. The smaller banks have performed better. You've seen the yield curve disinvert." McGratty highlights that mergers and acquisitions (M&A) are another trend in the banking sector, noting that 3%-4% of banks are lost to consolidation every year. "What we've seen over the past six months is we're starting to see M&A resume off a very low trough. So the comparisons are getting better," he says. As interest rates continue to fall, he expects M&A activity to pick up. However, he notes that won't likely be the case for larger banks as they deal with regulatory roadblocks. He points to Comerica (CMA) as one of his top picks, explaining that the bank is poised to benefit from easing interest rates: "They were very early and aggressive hedging rates as they were going up. So effectively, they've converted a highly variable rate loan portfolio to a 50/50 mix per se. So margins should actually begin to expand over the next two years." McGratty is also bullish on Western Alliance (WAL), believing that the bank's internal efforts to build capital have succeeded. He adds that its mortgage business will also get a boost from lowering rates. Western Alliance is trading at about nine times its earnings, and McGratty believes that its earnings ahead will be above average. For more expert insight and the latest market action, click here to watch this full episode of Market Domination. This post was written by Melanie Riehl