Investors take refuge in US regional banks as Fed hikes loom

The SPDR S&P Regional Banking ETF was up 2% year-to-date on Friday afternoon, compared to a 6.6% drop for the S&P 500. Gains in some individual banking stocks were even more eye-catching: Shares of Citizens Financial Group Inc are up 8.4% year-to-date, while shares of KeyCorp are up nearly 9%.

Regional banks derive a significant portion of their income from net interest margins, which is bolstering their appeal as investors increasingly expect the Fed to raise interest rates more aggressively this year to control inflation. The central bank is meeting next week and is expected to raise interest rates as early as March. [L4N2TZ0GW][L4N2TQ2J1]

Treasury yields rose in anticipation of tighter policy, with those on the benchmark 10-year treasury rising 40 basis points from recent lows.

Meanwhile, some investors expect the expanding U.S. economy and tapering fiscal stimulus to boost loan growth, helping regional banks post 70.1% profit growth. for the year 2021, the seventh fastest among the 126 sub-sectors of the S&P 500, according to Goldman Sachs.

“If you want to play on the steepening of the yield curve, the best way to do that is through regional banks,” said Moustapha Mounah, assistant portfolio manager at James Investment, which has increased its stake in companies. such as SVB Financial Group.

Although investors expect regional banks to benefit overall from rate hikes, the pace at which the Fed tightens monetary policy could be key. Too steep a path of rate hikes could hurt economic growth and potentially weigh on bank earnings, Mounah said, though such an outcome is not his baseline forecast.

Fed funds futures traders are fully anticipating a 25 basis point hike in March, in addition to three more rate hikes by the end of the year.

In addition to next week’s Fed meeting which ends on Wednesday, investors await earnings from Zions Bancorp, which is expected to release its latest quarterly results on Monday, followed by First Bancorp on Tuesday and United Bankshares Inc and Merchants Bancorp on Wednesday.

The pace of Federal Reserve rate hikes will directly affect industry earnings, said DA Davidson & Co analyst Gary Tenner. Tenner recently added two more expected rate hikes of 25 basis points to its valuation models. regional banks, bringing his total to four through the end of 2023, he said.

“The impact of higher interest rates is potentially more positive for regional bank estimates and returns” than so-called universal banks, which also derive investment banking revenue, he said. S&P 500 banks are up 0.4% so far in 2022.

In addition to an overly rapid pace of rate hikes, regional bank stocks could suffer if a stock sell-off that has already pushed the Nasdaq into correction territory accelerates further, suggesting the Fed will raise rates to a slower pace to avoid destabilizing the markets. [L1N2TZ2JG]

“There’s always this debate in the stock market about how much the Fed is going to raise and how fast. If the Fed backtracks, the rally we’ve seen here could slow down,” said Steve Comery, research analyst at GAMCO Investors. [L1N2TZ2JG]

Brady Gailey, managing director of Keefe, Bruyette & Woods, believes that even two or three rate hikes would be enough for the sector to post earnings growth that outpaces the market as loan growth picks up. He upgraded the regional banks sector to an overweight position in September.

“They should be the big beneficiaries of higher rates, but the sector has other fundamentals as well,” he said.

(Reporting by David Randall; Editing by Ira Iosebashvili and Cynthia Osterman)

By David Randall

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