The tide of operating environment has not been favorable since the beginning of 2014, but the U.S. banks proved their mettle and stayed afloat. In spite of the nagging, and perhaps heightened, structural pressure and weakness in key segments – capital market business and mortgage banking, cost containment and modest improvement in some segments managed to counter the stress.
Though overall loan growth remains tepid due to the dearth of mortgage demand, banks have been witnessing improving trends in auto lending and credit cards. Also, a pickup in commercial real-estate lending has endowed banks with significant exposure. Further, the boom in M&A and IPO activities is leading to solid investment banking business.
U.S. historical data depicts with a flattening of the yield curve, the net interest margin – banks’ key source of earnings – faces significant pressure. Unless banks see a rise in loans, which is impacted by slow economic growth and tough competition, low rates are causing net interest margin compression and consequently reducing net interest income.
Banks take deposits and lend them at a higher interest rate to customers. So, in a low interest rate environment, lower interest income is received, partially offset by lower interest paid to depositors.
After the initial benefit from low rates, net interest margins are continuing to reduce as funding costs reached lowest level and asset yields continue to decline. The longer low interest rates would prevail, the tougher will be for banks to cut payouts on deposits or charge more for loans.
In a still-weak economy, they also hesitate to lend to consumers and businesses. Therefore, in a prolonged low interest rate scenario, banks are being forced to resort to fee-based revenue sources and improve operating efficiency to boost profitability.
We believe any expansion in net interest margins would be a positive for bank profitability. Precisely, banks maintaining securities portfolios with short durations could be benefitted by rising short-term rate scenario through higher reinvestment rates. Rising rates may reinstate banks’ profitability but rapid increase may dent their health. A rising interest rate could widen the spread for certain banks.
However, rising rates without support of significant economic recovery would impact profitability in many sectors of the economy, on which banks depend for their earnings. Moreover, the balance sheet is affected when rising interest rates change the value of liabilities and assets and reduce net worth of the banks. Due to the maturities gap, bank assets and liabilities are impacted differently by an interest rate rise. If assets lose value while the liabilities are intact, the net worth drops, affecting their capital levels.
Nevertheless, we expect operating conditions for these banks to become more favorable as economic growth accelerates and benchmark interest rates rise in 2015.
Stocks Worth Betting On
Rising interest rates can be a positive factor for banks if they are prepared for it. So one may consider buying some bank stocks with 60–65% of revenues tied to net interest income (NII). Along with the expected benefit from rising rates, their strong fundamentals and a favorable Zacks Rank promise better performance in the future.
Here we have handpicked 4 such stocks:
Comerica Inc. (CMA) has a long-term earnings growth rate of 10.45% and carries a Zacks Rank #3 (Hold). It generates roughly 66% of its revenues from NII.
SunTrust Banks, Inc. (STI) has a long-term earnings growth rate of 18.16% and carries a Zacks Rank #3. It generates about 62% of its revenues from NII.
MB Financial Inc. (MBFI) provides financial services primarily to small and middle market businesses and individuals. It has a long-term earnings growth rate of 10% and carries a Zacks Rank #2 (Buy). It generates roughly 61% of its revenues from NII.
Huntington Bancshares Inc. (HBAN) has a long-term earnings growth rate of 10.98% and carries a Zacks Rank #3. It generates about 66% of its revenues from NII.
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