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Sector Snap: Will rate jumps benefit small banks?

Christina Rexrode, AP Business Writer

NEW YORK (AP) -- Citi Investment Research analysts said Wednesday that they've "scrubbed" their models for second-quarter earnings at regional banks, because of the recent steep changes in interest rates.

THE BACKGROUND: Interest rates are pivotal in bank earnings. When interest rates are low, as they are now, banks don't have to pay as much to customers for their deposits. But the banks also can't charge as much when they make loans, and the banks have been complaining for several years that low interest rates are hurting their results.

THE FED EFFECT: Interest rates have been rising in recent weeks, however, because investors think the Federal Reserve could soon stop buying so many government bonds. That's made investors pull out of bonds, which has sent their interest rates up, because the government has to pay more to persuade investors to buy them.

For example, a 10-year Treasury note now pays about 2.5 percent, compared to 1.9 percent on May 21. That was the day before Federal Reserve Chairman Ben Bernanke said the central bank could soon rein in its bond-buying program.

THE SPARK: The Citi analysts, led by Josh Levin, guessed that short-term rates — which are closely linked to bank rates — would soon follow suit and head higher.

The federal funds rate, which is the rate at which banks lend money to each other overnight, is at about 0.09 percent, compared to 0.1 percent on May 21.

While those higher rates would require regional banks to pay more to customers for their deposits, the analysts guessed that the rates would in the end be a net benefit as the banks charged more for loans.

THE ANALYSIS: The analysts raised their stock price estimates for 10 regional banks, and predicted that other analysts would soon follow suit. They also raised their ratings on Zions Bancorporation to "Buy" from "Neutral," and on Comerica to "Neutral" from "Sell."

SHARE ACTION: Zions added 14 cents to $29.67 late in the holiday-shortened session, after earlier trading as high as $29.98. Comerica rose 29 cents to $41.02, off the session high of $41.11. Other regional banks, including KeyCorp, Regions and SunTrust, were also slightly higher.