Why Regional Banks Might Be the Value Play Everyone's Missing

Key Points

• Regional banks can benefit from falling interest rates as deposit costs typically adjust downward faster than loan yields.

• Lower rates also stimulate borrowing demand, boosting loan growth.

• Regional banks that struggled amid higher interest rates could see their margins recover faster if funding costs come down.

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On Sept. 18, the Federal Reserve cut its benchmark interest rate by 0.25%. It was the central bank's first interest rate cut since December, as it looks to balance both sides of its dual mandate to achieve both stable prices and maximum employment.

Interest rate cuts benefit companies with more debt, including small-cap stocks. One value play that investors might be overlooking is regional banks. Here's why.

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How interest rate cuts could benefit regional banks

Regional banks can benefit from interest rate cuts because their deposit costs typically adjust downward faster than loan yields. Most deposits are short-term and rate-sensitive, while many loans are fixed or repriced more slowly. This timing gap can boost net interest margins, easing pressure from prior rate hikes.

Lower rates also stimulate borrowing demand, boosting loan growth and fee income. Together, these dynamics can boost profitability and capital flexibility for regional banks during easing cycles. The primary beneficiaries are banks with strong deposit franchises, sensitivity to interest rates, and balance sheets heavily tilted toward lending.

PNC Financial is one regional bank with a relatively low deposit beta, supported by a stable, low-cost funding base and broad geographic reach, with a balance sheet tilted toward lending. By contrast, more asset-sensitive peers such as Zions Bancorp and KeyCorp, whose earnings were pressured by higher deposit costs in the rising rate environment, could see outsized margin recovery if funding cost sensitivity eases with rate cuts.

How investors could play the rebound

For investors, rate cuts create an opportunity in regional banks. As funding costs ease faster than loan yields, margins expand, credit demand rises, and earnings improve.

With valuations still compressed from pressures that emerged during the regional bank crisis a couple of years ago, regionals could deliver solid upside as monetary policy becomes a tailwind. For those interested, the SPDR S&P Regional Banking ETF (NYSEMKT: KRE) is one way to play the rebound across a diverse group of over 140+ regional bank stocks.

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Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.