The prospect of rising interest rates has spooked the banking industry, but certain lenders are poised to profit handsomely when the era of near-zero rates comes to a close.
Commercial banking companies like M&T Bank Corp., Cullen/Frost Bankers Inc. and Comerica Inc. have either enviable amounts of core deposits or lots of variable-rate loans that could become cash cows as rates rise. Some, like M&T, have both. And then there are those sitting on lots of cash that they may be able to turn into high-earning assets as rates climb.
"Some commercial banks should benefit from higher rates because, traditionally, when rates are at zero, your demand deposits aren't earning any money," said Fred Cannon, co-director of research at KBW Inc.'s Keefe, Bruyette & Woods Inc. "They can't wait for rates to rise."
Other financial services groups with strong asset management arms, like Northern Trust Corp. and Bank of New York Mellon Corp., will be able to resume charging fees on money-market funds, which they have been waiving because of low short-term rates.
Those lenders are in contrast to companies like JPMorgan Chase & Co., which stands to lose $500 million on a 1-percentage-point interest rate increase, CEO Jamie Dimon said last week. Market watchers have been fretting that the Federal Reserve will raise rates across the board, and sooner rather than later, after its surprise increase last month in the discount rate it charges banks to borrow emergency funds. A broader rate increase could erode banks' profits by hindering their ability to borrow money cheaply and lend it out at higher rates, but experts say the pain would not be universal.
"The conventional logic is, when rates go higher, typically, the yield curve flattens out," said Brent Rabatin, an analyst at Sterne, Agee & Leach. "That usually is not a positive for banks that are, quote, 'lending long and borrowing short,' from a margin perspective. There are converses to all that."
A rise in rates would mean that asset managers, for example, could resume charging fees to invest clients' money in short-term instruments like Treasury bills, which have generated scant return, given negligible short-term rates. Bank of New York Mellon has said it waived $74 million in fees in the fourth quarter alone.
"Short-term interest rates, we all know where they are, and eventually they're going to have to go up. And we've been saying for some time now that we will benefit quite materially" when that happens, Bank of New York Mellon CEO Robert P. Kelly said during a banking conference in February.
Low-rate demand deposits and floating-rate loans become incrementally more valuable as rates rise because the loans reprice more quickly than the liabilities do.
"A bank that has got sticky checking accounts and variable-rate loans is going to do better in a rising rate environment," Cannon said.
M&T fits that description.
The Buffalo company classified 82% of its deposits — $39.1 billion — as core at Dec. 31 in its annual report. And about 54% of its $51.9 billion in loans contractually reprice in three months or less, the report said.
Raymond James Financial Inc. analyst Amanda Larsen said M&T is a classically "asset-sensitive" lender positioned to reap the benefits as its assets reprice faster than its liabilities. "Core deposits are the best weapon in a rising-rate environment," she said. "They have one of the best core-deposit bases in the country."
Cullen/Frost in San Antonio is also sitting pretty when it comes to potential rate hikes.
Rabatin said that about 80% of Cullen/Frost's nonequity funding comes from core deposits. Also, it has $4.6 billion in noninterest-bearing deposits, a huge source of cheap funding that can be deployed at high margins when business loan demand picks up. He estimated that the company also has a lot of variable-rate commercial loans and about $1 billion in excess cash.
"If you are thinking about names that are going to benefit from higher rates, think about Cullen/Frost, think about Comerica," he said. "Comerica has the same thing going on."
Comerica is a lender with lots of liquidity and lots of variable-rate loans. KBW estimated that 80% of its $42 billion in loans are floating rate, with 75% of these notes tied to the London interbank offered rate. It also has about $2.4 billion in "excess liquidity," KBW said in a report last week.