Star-Bulletin news services
Big, diversified banks
weather rising interest
rates better than others
NEW YORK » Whenever Wall Street is worried about rising interest rates, the market almost automatically sells off banking stocks, in the belief that higher rates will hurt their future earnings. But analysts say tightened rates don't necessarily spell doom for all banks.
Sweeping changes within the industry have made banks larger, more diverse and more sophisticated at managing risk, including interest rate fluctuations. In some cases, rising rates might even boost profits. Because all banks are built differently, it's wise to evaluate these stocks on a case by case basis.
"It's so difficult to make broad generalities anymore about the financial services sector, as it pertains to rates," said Craig Woker, associate director of equity research at Morningstar Inc. "Maybe it was easier when there were a lot of small firms across the nation focused on the same type of business. But now ... you almost have to look at how each individual bank's balance sheet is broken down."
The most rate-sensitive financial stocks are typically regional banks, consumer credit card companies and firms heavily dependent on residential mortgages. Companies like this, such as Washington Mutual Inc., National City Corp. and Countrywide Financial Corp., benefited greatly from the recent refinancing boom, when homeowners rushed to take advantage of historically low rates.
Now, left with the more mundane business of servicing those mortgages and with little prospect of another profit spike, their earnings are likely to flatten or fall over the next year or two.
Larger, more diverse financial institutions will fare better as rates rise. They're more likely to have moved assets to short-term securities in anticipation of the eventual rate hike, which will boost their bottom lines. In addition, banks that offer more products and services are likely to derive a higher percentage of income from fees and transactional costs -- everything from insurance, brokerage and checking account charges to the $1.50 you pay whenever you use their automatic teller machines.
The improving economy, which is what made it possible for the Federal Reserve to consider raising rates in the first place, is also likely to work in the big banks' favor. During good times, the demand for commercial loans goes up as businesses look to expand. Unlike residential mortgages, which are often fixed at a low rate, commercial and industrial loans are usually adjustable, meaning they are repriced as rates rise. From a bank's perspective, they're a better investment.
In a recent study of the industry, Collyn Gilbert, senior bank analyst with Ryan Beck & Co., identified a high percentage of fee income and a bigger proportion of commercial and adjustable rate loans as two important factors for determining how well a bank is positioned in a rising rate environment.
"Now is a good time to own a Citigroup, a large, diversified financial corporation," Gilbert said.
"They're much more sophisticated and less subject to volatility."
If you're looking to invest in smaller companies, she said, you might focus on those with a higher concentration of commercial loans, because that's the segment of the economy that is expected to improve, and that's the portion of their loan portfolio that will be repriced as rates rise.
There's another factor at play in the current market, as well: The rise in merger and acquisition activity has helped regional banks hold up more than they might otherwise, because investors are betting they'll be snapped up by bigger firms. So far this quarter, the financial sector is down 2.2 percent, while regional banks are up 1.1 percent.
"You'd normally expect the regional banks to sell off when interest rates are about to rise, but so far in the second quarter they're outperforming the sector as a whole," said Jeff Kleintop, chief investment strategist for PNC Financial Services Group in Philadelphia. "That's absolutely related to merger speculation."
Regardless of the stock in question, short-term swings in interest rates should be just one many variables long-term investors consider before striking the buy or sell button.
"You want to seek out banks that look like good bargains, that are also going to be able to grow and perform well, no matter what the interest rate environment is," said Woker, of Morningstar. "A shift in short-term interest rates will have an impact on a bank for one or two years, at the absolute most. So if you're a long term investor, it shouldn't matter."
STOCK QUOTES/CHARTS/DATA
