Bank stocks — one of the few direct beneficiaries of tighter monetary policy — are in the spotlight as policymakers from the Federal Reserve gather for the central bank’s annual retreat in Jackson Hole.
While few expect any policy announcements to come out of this week’s meeting, investors are hoping for more clarity on how Fed officials view the risks posed by inflation and whether they will be able to contain higher rates without spurring the economy. in recession. While many fear the tools at the Fed’s disposal—namely, raising interest rates—banks stand to gain because higher borrowing costs translate into higher margins for lenders.
“The biggest driver of profitability over the next 12-18 months will be the continued improvement in net interest margin (NIM) due to higher short-term interest rates and the redeployment of excess liquidity to higher-yielding assets,” said Gerard Cassidy, analyst at RBC Capital Markets, wrote in a note.
That said, not all banks benefit equally when interest rates rise.
Just look at the performance of investment banks such as
(tick: GS) and Morgan Stanley (MS) for much of the past two years. Pandemic-induced low interest rates combined with looser fiscal policy allowed them to post record profits and outperform peers on deal-making, initial public offerings and trades as businesses and investors took advantage of the easy money. While Morgan Stanley and Goldman Sachs are expected to continue to perform well, no one believes they will get a similar boost from higher interest rates.
For this, investors will want to look at lenders that derive more of their income from banking. And even in this broad category, there are standouts. Cassidy and his team at RBC looked at the banks they cover, from large-cap lenders such as
the bank of america
(BAC) to regional players like
(RF) and evaluated their profitability based on return on assets and return on equity.
By evaluating each of the banks’ income statements against their respective assets, Cassidy said, he found he was better able to determine what drives each bank’s profitability and how it might outperform as interest rates rise. Not surprisingly, the largest money-center banks have a lower level of net interest income relative to their average assets than their regional peers because they are required to keep lower-yielding, more liquid securities on their balance sheets, wrote Cassidy. Banks that get more of their income from lending get a bigger boost from charging more for loans as interest rates rise.
From a group of 20 banks, Cassidy identified 11 that were particularly well positioned for the current environment. bank of america,
(C), Fifth Third (FITB), Huntington (HBAN),
(KEY) and Regions Financial (RF) led the list. These lenders have less risk on their balance sheets and “weathered” the initial shock to markets during the pandemic, according to Cassidy.
These banks also have more room to improve their valuation, Cassidy explained in an email to Barron’s. While
(JPM) is a leader in profitability, its success likely already reflected in its valuation, he said.
Beyond lenders net benefiting from higher interest rates, Cassidy also advises owning
PNC Financial Services
(USB). All these banks are “high quality”, he said.
Bank stocks have had a volatile year. The
SPDR S&P Bank
The ETF (KBE) fell more than 20% in June in response to concerns that the U.S. will slide into recession. It is now down nearly 8% so far this year, doing better than the
which decreases by almost 12%.
Write to Carleton English at email@example.com