Regional bank indexes have returned to levels not seen since the March crisis, marking an important milestone for an industry recovering from one of its toughest years since the 2008 financial crisis. The SPDR S&P 500 regional bank index (KRE) and the KBW Nasdaq US regional bank index (^KRX) both experienced their best single-day performance in the last month on Wednesday and continue to climb on Thursday. Another index, the KBW Nasdaq US bank index (^BKX), is also approaching the levels it last reached on March 9, following a surge in the past two days.

The resurgence in regional bank indexes can be attributed to a shift in stance by the Federal Reserve, as it indicates an end to interest rate hikes after its aggressive tightening campaign over the past years. On Wednesday, Fed officials announced that they now anticipate three rate cuts in 2024. This news comes as a relief to regional bankers who have been grappling with challenges such as increased deposit costs, higher paper losses on investment bonds, and difficulties faced by borrowers due to elevated rates.

Don McCree, head of commercial banking for regional lender Citizens Financial (CFG), expressed his enthusiasm about the development, stating, "This is nothing but good for our business." Citizens Financial saw its stock rise more than 9% on Thursday, along with several other regional banks that faced market pressure earlier this year. Scott Siefers, a large and regional bank analyst with Piper Sandler, expressed cautious optimism, saying, "I'm certainly hopeful that the worst is behind us."

Despite the recovery, regional bank stocks have still lagged behind the S&P 500 this year, despite rebounding from the significant decline experienced in the spring. In May, the indexes were down 30% from the beginning of the year. As of midday trading Thursday, the two regional bank indexes remain down 2% and 8% for the year.

However, industry executives and analysts recognize that challenges persist and are hesitant to declare that the banking sector has completely overcome its problems. Deposit costs are expected to continue rising until interest rates are actually lowered. Additionally, concerns remain regarding delinquency rates on certain bank loans, with commercial real estate loans tied to office spaces being a particular worry.

Chris Whalen, a bank investor and analyst with Whalen Global Advisors, highlighted the need to address credit outcomes in commercial real estate, stating, "The rally is most welcome but won't change credit outcomes in commercial real estate. Credit is the next shoe to drop for banks."

In order for regional banks to fully benefit, the ideal scenario is for short-term rates to fall below long-term rates. This would enable mid-sized institutions to charge higher interest rates on loans compared to what they pay out on deposits.

While the climb back to pre-crisis levels signifies positive progress for regional banks, the industry's future outlook is still dependent on the reasons behind the Federal Reserve's shift in rates next year. Analyst Scott Siefers emphasized that if rate cuts are driven by successful inflation management, it would be favorable for the banking sector. However, if aggressive rate cuts are required due to an unforeseen economic downturn, the narrative would be different.

Overall, regional banks are cautiously optimistic as they begin to regain lost ground, but challenges such as credit risks and uncertainty surrounding interest rates still loom large.