U.S. banks are in a sweet spot - one that could get a lot sweeter. Interest rates are likely to keep rising, which will increase net interest margins and, thus, profits. There also is the possibility of a boost from a lower corporate tax rate, financial deregulation and a pickup in economic growth.
In general, mid-cap regional banks stand to gain the most. Their business is oriented toward the domestic market and will benefit the most from higher interest rates and the loan growth that would accompany a pickup in economic growth. Mid-caps also will benefit strongly from tax cuts. And their smaller size means regulation can be more burdensome than for big banks, so less regulation would give mid-cap regionals a major boost.
There is, however, an important caveat. The extent to which higher interest rates will benefit any particular bank depends on the specifics of that bank's balance sheet, cautions Lisa Welch, senior managing director, financial institutions team, and senior portfolio manager with Manulife Asset Management (U.S.) LLC in Boston. Banks that carry a large number of variable-rate loans will benefit almost immediately, as rates for those loans rise quickly.
But if banks are heavily weighted toward long-term loans at fixed rates and pay an increasing amount of interest on deposits, their earnings will be dampened.
The U.S. Federal Reserve Board believes that the U.S. economy is strong enough to keep growing, even with the drag of higher interest rates. The Fed has raised rates twice already: by 25 basis points (bps) in December and by another 25 bps in March. The Fed has stated there could be two more increases this year and possibly three in 2018.
That many hikes, however, may be dependent on whether U.S. President Donald Trump can spur strong economic growth through the combination of tax cuts, infrastructure spending and deregulation, as he has promised. However, the political will to make these changes may be lacking.
Most Republicans support tax cuts, but a significant number in that party are against boosting the federal deficit to pay for infrastructure. Trump probably could get some support from Democrats for the infrastructure spending, but they wouldn't be enthusiastic about a big corporate tax cut.
There is general support in Congress for lessening the burden on businesses, but major cuts in banking and investing regulations may not be possible. For example, there is no consensus that the Dodd-Frank reforms of 2010, designed to prevent another credit crisis, should be dismantled.
Here is a selection of banks that may particularly benefit from rate hikes:
- citizens financial group inc. Based in Providence, R.I., this is a northeastern U.S. franchise. In the past few years, Citizens Financial Group has restructured and become much more focused. The stock currently trades at less than book value.
- comerica inc. This bank will be a major beneficiary of higher interest rates, Welch says. Comerica, based in Dallas, has a presence in Arizona, California, Florida, Michigan and Texas. She notes that Comerica's focus on high-quality loans meant the bank didn't have many losses when oil prices dropped.
- key corp. This Cleveland-based bank has branches in the northeast, Ohio, Indiana, Michigan, Utah, Colorado, the northwest and Alaska. Welch says earnings should rise as Key cuts costs and generates revenue synergies from its acquisition of Buffalo-based First Niagara Financial Group Inc. in July 2016.
- svb financial group. Based in Santa Clara, Calif., this bank is the parent of Silicon Valley Bank, which specializes in financing for high-tech startups. SVB "probably will be one of the biggest beneficiaries of high interest rates because it has a lot of adjustable rate loans," Welch says.
- bank of america (bofa). Although Charlotte N.C.-based BofA has global operations, it has a "good domestic franchise with huge market share," says Charles Burbeck, managing director, global equities, at UBS Global Asset Management (U.K.) Ltd. in London. As such, he says, BofA is "a play on increasing interest rates and, to a lesser extent, on deregulation."
Burbeck notes that BofA has had "subpar" returns on its retail banking in recent years and says those earnings will rise with higher interest rates. He also points out that the bank has restructured and cut costs, and that the majority of the enormous legal issues that arose out of the global financial crisis have been left behind.
BofA still trades below book value and should be trading above book value, Burbeck says. He anticipates return on equity to be double-digit in the next couple of years vs the current 6%-7%.
An article in the June issue will discuss investment opportunities in U.S. banks that cater to niche markets and mergers.
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