Investing in the Face of a Rate Hike: Regional versus Large Banks
Low interest rates and margins
Low interest rates have been weighing down regional banks’ profit margins in 2015. In her statement on November 4, Federal Reserve Chair Janet Yellen noted that there was “a live possibility” that the Fed would raise the benchmark interest rate in December.
Meanwhile, in conjunction with falling unemployment data, the positive jobs report released on November 6 further supported the probability of a rate hike at the December FOMC (Federal Open Market Committee) meeting. Since that time, there has been increasing confidence that the Fed would begin raising rates in December, which has fueled banking stocks (XLF), given the general belief that a rise in interest rates will lead to expansions in banks’ margins.
Would regional banks benefit from a rate hike?
Most regional banks (IAT) have had strong balance sheets in 2015, and their quality of earnings has been improving in concert with the strengthening US economy. Solid loan growth, higher trading income, rising credit quality, and litigation settlements have all contributed to this strength in regional banks.
At the same time, as regional banks’ loan portfolios gain health, the banks will need smaller loan loss reserves in the future, which often results in gainful trading for banking stocks. Backed by the robust fundamentals of regional banks, investors are increasingly showing interest in the regional banking space as of November 13, as we can see in the fund flows to regional bank ETFs in early November.
What fund flows to KRE tells us about investors
As of November 13, 2015, exchange-traded fund investors ploughed $244 million YTD (year-to-date) into the SPDR S&P Regional Banks ETF (KRE). In the first two weeks of November, KRE gained $190 million in assets.
During the week ending November 13, investors added a whopping $154 million to KRE, an ETF that particularly targets regional banks in the United States. KRE’s top holdings are Bank of the Ozarks, (OZRK) Western Alliance Bancorporation (WAL), BBCN Bancorp, Home BancShares, and Simmons First National Corporation Class A (SFNC), and Regions Financial Corporation (RF).
But what do other experts suspect about the probable rate hike in December? Continue to the next part of this series to find out.
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