Bank Stocks In Focus As Fed Signals Rate Hike In June

Several bank stocks rallied on Wednesday after Federal Reserve officials signaled a likely interest rate hike decision in June’s policy meeting. Of course, the decision depends on continued economic strength.

Per the minutes of the Federal Open Market Committee Apr 26-27 policy meeting released on Wednesday afternoon, “Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.”

At the same time, some of the officials also highlighted that the global financial markets could be sensitive to several issues including the impending British referendum on membership in the European Union and unexpected developments tied with China’s management of its exchange rate.

Nevertheless, the Fed funds futures market now sees a 34% chance of interest rate rise in June, compared with just 15% on Tuesday and below 5% last week, according to the CME Group (NASDAQ:CME) FedWatch tool that facilitates investors to view the likelihood of an upcoming Fed Rate hike.

Why Banks Socks Grabbed Attention

Banks typically benefit from higher rates. The benefit primarily comes from a steep yield curve, i.e. when the spread between long-term and short-term rates is wide. The interest rates on deposits are usually tied to short-term rates while loans are often tied to long-term rates. This means that the potential rise in rates will enable the banks to charge more for loans, leading to an increase in their spread income.

The full quarter impact of the December Fed rate hike was a key watchable area in the Q1 earnings results for banks.

The following banks have acknowledged the benefit from the rate hike in Q1. These banks have also provided guidance based on the likely benefit from rate hike.

Fifth Third Bancorp (NASDAQ:FITB) : The bank’s net interest income (NII) increased $5 million in first-quarter 2016 from the prior quarter to $909 million on a fully taxable equivalent (FTE) basis. The rise was mainly due to improvement in loan yields driven by the December Fed funds rate increase. However, management also noted that the rise was partially offset by several factors including continued loan yield compression due to mix shift to lower yielding, higher quality credits, reduction in the Fed stock dividend rate and a less day count.

The net interest margin (NIM) increased 6 basis points (bps) sequentially to 2.91%.

Guidance: Management considers only one rate hike in June compared to previous expectations of two (one in June and the other in September). In the event of no further rate hikes in 2016 and considering the impact of the dividend reduction on the Fed shareholdings, the company projects NII to grow 2%.

Price Action: The stock was up 4.58% at the close on Wednesday.

SunTrust Banks, Inc. (NYSE:STI) : NII improved 2.9% sequentially to $1.3 billion in the first quarter 2016. The increase was due to loan growth along with higher loan yields driven by the December rate hike. NIM improved 6 bps sequentially to 3.04%.

Guidance: Though NIM improved in the first quarter, management expects it to fall a couple of bps on a quarterly basis for the remainder of 2016 (If the Fed doesn’t initiate any further rate hikes this year). Nonetheless, if the Fed raises rates later this year, NIM will benefit from the same, given its modest asset sensitive position. Management also expects NII to grow albeit at a low rate, irrespective of rate movements. However, such growth is anticipated to accelerate in case of further rate hikes.

Price Action: The stock was up 4.16% at the close on Wednesday.

First Horizon National Corp. (NYSE:FHN) : NII improved 3% sequentially to $172.1 million in the first quarter 2016. NIM improved 6 bps sequentially to 2.88%. Management noted that the increase in both NII and NIM was led by the December rate increase.

Guidance: Based on expectations of two interest rate hikes by the Federal Reserve in 2016, First Horizon predicts only a modest increase in NIM during the year, given its reduced asset sensitivity. Moreover, NIM is likely to experience quarterly fluctuations. However, in the absence of anticipated rate increases, NIM is expected to remain stable throughout the year, driven by a disciplined loan pricing.

Management expects that at 25 bps rate hike, the company may record 1% benefit, or $7 million to its NII. Likewise a 50 bps rate increase scenario (considering two hikes), it may witness 2.4% or $17 million benefit to NII.

Price Action: The stock was up 4.56% at the close on Wednesday.

Regions Financial Corp. (NYSE:RF) : The bank's NII and other financing income on FTE basis increased 3.2% from the previous quarter to $883 million in the first quarter 2016. Excluding a certain lease adjustment, NII increased 1%. Management noted that the rise was driven by an increase in short-term rates, higher loan balances and lower premium amortization. However, the increases were partially offset by reduced dividends on Federal Reserve stock and one less day in the quarter. NIM improved 11 bps sequentially to 3.19%.

Guidance: Management noted that during first quarter it saw $5–$7 million in NII benefit related to lower premium amortization and higher dividend income related to trading assets. However, such benefits will not occur in second quarter. Excluding such impacts, NIM starting point for the remainder of the year stands at 3.14%. Management also noted that NIM will likely experience a modest pressure if rates remain low. However, further increases in short-term rates will aid in stabilizing the margin.

Price Action: The stock was up 5.13% at the close on Wednesday.

Citizens Financial Group, Inc. (NYSE:CFG) : NII increased 4% sequentially to $904 million, benefiting from the higher interest rates, commercial and retail average loan growth and stable deposit costs. NIM improved 9 bps from the fourth quarter 2015 to 2.86%.

Guidance: Compared with the first quarter 2016, NIM is expected to remain stable. For full year 2016, NII is projected to rise 7–10% year over year, and NIM is expected to show improvement of 6-12 bps from 2015 level.

Price Action: The stock was up 6% at the close on Wednesday.

Bottom Line

The long-awaited December 2015 rate hike certainly depicted how the U.S. economy has gradually gained traction since the 2008 financial crisis. While the final move by the Fed at its June 14-15 meeting will depend largely on the slew of readings in several areas including consumer spending, housing sector, job report and industrial production, the recent positive trends so far in second-quarter including industrial production, retail sales and housing sector, should support inflation.