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Rising Rates Are Great for These 5 Regional Bank Stocks

December 4, 2015 Stock Analysts 0

The European Central Bank (“ECB”) cut its deposit rate by 10 basis points to -0.3% and extended its asset purchase program by six months to at least the end of March 2017, in order to overcome weak growth and lift inflation. This undermined the expectations of the market, which anticipated higher reduction in the deposit rate and a probable cut to the refinancing rate.

However, with all eyes on the Federal Reserve’s next policy meeting to be held Dec 15–16, the monetary policy stimulus program of the ECB was overshadowed by the potential increase in interest rates in the U.S.

The Fed has been cautious due to overall weak economic data in the second and third quarter of 2015. However, now with the moderate pace of economic growth, recent strong gains in the labor market, including an October jobs report that showed employers added 271,000 new positions, pushing unemployment down to 5% and inflation target expected to return to the Fed’s 2% target, chances of a rate hike looks promising. The Fed Chair Janet Yellen also hinted at this.

“I currently judge that US economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market,” she said in a speech on Thursday. “Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2%.”

Moreover, Yellen expressed similar confidence on the state of the U.S. economy in a speech to the Economic Club of Washington on Wednesday. Nonetheless, the rate-hiking cycle will be gradual and dependent on the performance of the U.S. economy, which is expected to keep borrowing costs low for consumers and businesses.

November jobs report is the only piece of remaining economic data at this stage that can have a bearing on the Fed decision. However, the jobs report needs to be majorly disappointing to stop the Fed from announcing a rate hike this month.

Why Banking Is a Good Bet

Consumer discretionary, financial and technology are the sectors most affected by the prolonged lower interest rate scenario. Most financial entities like banks, insurance companies, brokerage firms and money managers will benefit from rising rates as margins expand.

Banks derive benefits from a steep yield curve, i.e. when the spread between long-term and short-term rates is wide. The interest rates on deposits are usually tied to short-term rates while loans are often tied to long-term rates. This means that the potential rise in rates will enable the banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits.

Moreover, an improving economy means that credit quality will likely improve, which will also aid banks' profitability. Thus, banks’ earnings would grow and forecasts will be raised with an increase in interest rates, thereby leading to a rally in banking stocks.

5 Regional Bank Stocks to Bet On

We have selected 5 banking stocks that are currently well positioned to gain from a rate hike. For selecting these stocks we have used our style score system.

Our Growth Style Score condenses all the essential metrics from the company’s financial statements to get a true sense of the quality and sustainability of its growth. Our research shows that stocks with Growth Style Scores of ‘A’ or ‘B’ when combined with a Zacks Rank #1 (Strong Buy) or #2 (Buy) offer the best investment opportunities in the growth investing space.

Based in Illinois, Old Second Bancorp Inc. OSBC operates as a holding company for Old Second National Bank that provides a range of banking services. It offers checking, demand, NOW, money market, savings, time deposit, individual retirement, and Keogh deposit accounts; lines of credit for working capital; lending for capital expenditures on manufacturing equipment; and lending to small business manufactures, service companies and medical and dental entities as well as specialty contractors.