Bank Stocks' Tide Likely to Ebb If Fed Raises Interest Rates Today

If the Federal Reserve shifts course and raises interest rates today, analysts predict it will usher in a much more uncertain period for bank stocks.

"We are not expecting a rate hike by the Fed, but should there be one, we think that would lower the outlook for the stocks," said Raphael Soifer, a banking and financial services analyst at Brown Brothers, Harriman & Co., New York.

"I don't expect these stocks to do badly," added Frank W. Anderson, bank analyst at Stephens Inc. in Little Rock, "but they clearly do much better in a lower-rate environment than when rates are rising."

Bank earnings fared well the last time the Fed went into a rate- tightening mode, in 1994, but their stocks eventually did not. The stocks plunged during the last quarter of that year as higher rates slowed the economy.

The stocks rebounded when the Fed went into a more accommodative stance. So far this year, banks have outperformed other stocks in the wake of three rate cuts by the Fed between July 1995 and last January.

The Standard & Poor's bank index is up nearly 20% for the year, compared with a 15% gain for the Dow Jones industrial average and 11.5% for the S&P 500.

"If the Fed raises rates, the immediate questions in the market are going to be about the next increase - when and how much. If they go up enough and the economy slows, then credit quality concerns will start coming into play," Mr. Anderson said.

"All the wisdom seems to be that the market has discounted a rate hike, but I would be surprised if we escaped with no impact," the analyst said. "Investors would move into a more cautious zone and make it much harder for banks to keep outperforming."

In the short run, a rate hike would be good for bank earnings, especially at regional banks, Mr. Anderson said. "They have more prime- based loans funded by core deposits and transaction accounts, meaning their margins will actually improve slightly if rates rise.

"The banks have adjusted their portfolios and insulated themselves to the extent that a 200 basis-point movement in rates, up or down, may impact their net interest income by only 5%," he said.

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