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Hooray for Rate Hikes
Contrary to popular belief, stocks can fare well in the face of rising interest rates, even financial stocks. Here are seven banks analysts bet will benefit.
By Steven Goldberg, Contributing Columnist, Kiplinger.com
June 15, 2004
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Fears of rising interest rates are giving stock watchers whiplash. As usual, the market is overreacting to the misconception that any increase to the Fed's short-term interest rates hurts stocks.
Historically, stocks tend to rise after both the first and second interest rate hikes by the Federal Reserve Board. It's only after a string of rate hikes that stocks tend to level off or decline.
Why should stocks rise in the teeth of Fed increases? If you think about it, the reason is obvious. The Fed doesn't raise interest rates unless the economy is firing on all cylinders.
And the economy is doing quite well currently. Corporate profits are surging, and should continue to rise handsomely for at least 12 months.
Of course, if serious inflation sets in, and the Fed is forced to tighten the money supply severely, that will choke off the recovery. But so far that seems unlikely.
In the meantime, stocks still look reasonably priced.
Bank stocks can do well
Research by brokerage Ryan Beck & Co., which specializes in small to mid size banks and thrifts, shows that many bank stocks may see profits rise even as interest rates increase.
Conventional wisdom has been that all banks suffer from rising rates. But that's out of date. Banks hedge their interest-rate exposure. After all, they've seen rising rates coming, too.
Ryan Beck analyst Anthony Davis looked at what would happen to different groups of banks if interest rates increase. He found that the regional banks the firm covers, on average, would see their net interest income rise 0.44% over 12 months if rates rise one percentage point. Net interest income would rise even further, by 0.74%, if rates rise two percentage points.
That would translate into higher earnings, Davis says. A two percentage point rate hike would mean a 0.9% increase in average earnings per share for regional banks.
Rate hikes would help smaller community banks even more. They'd see net interest income increase by two percentage points over the following 12 months if rates rise one percentage point. A two percentage point rise would translate into a four percentage point increase in net interest income -- and a 5.8% increase in earnings per share.
Why will rising rates help these banks? For one thing, they have lots of non-interest bearing deposits, such as ordinary checking accounts. What's more, most of these banks' loans are at variable rates that readjust upwards as interest rates rise.
Of course, not all banks would be helped by rising rates. Savings and loans, for instance, will be hurt by rising rates. Those institutions likely to suffer the most earnings damage include Capitol Fed (CFFN), Charter One (CF), Dime Community (DCOM), Independence Community (ICBC) and New York Community (NYB), Davis says.
Banks to bet on
We asked Ryan Beck analyst Collyn Gilbert which banks would likely do best in a rising rate environment. Here are her picks, as well as her reasoning.
City National (CYN) has 91% of its deposits in accounts that pay no or low interest. And deposits are growing as the bank gains customers.
Columbia Bancorp (CBMD) charges variable, market-dependent rates on most of its loans. Higher rates should increase the bank's profits.
Fulton Financial (FULT) has recorded more than 20 straight years of rising earnings. So management knows how to make a buck in all environments. A two percentage point rise in rates should mean a 5% increase in net interest income.
Mercantile Bankshares (MRBK) is among the banks best positioned to benefit from higher rates. What's more, commercial loan demand is likely to rise, too, and those loans are at variable rates.
Valley National (VLY) should see net interest income rise nearly 7% if rates increase two percentage points. And the bank has a long record of high profit margins. It has raised dividends in 34 of the last 35 years.
Virginia Commerce (VCBI), in the fast-growing suburbs of Washington, D.C., is one of the most profitable community banks in the country. Earnings have consistently grown 20% to 25% annually. Plus, the bank will benefit from rising rates.
Wintrust Financial (WTFC) is the bank in Ryan Beck's universe that will do the best if rates rise. A two percentage point rise in rates should translate into nearly a 10% rise in net interest rate income over the subsequent 12 months.