Please ensure Javascript is enabled for purposes of website accessibility

1 Reason Bank Stocks Will Soar in the Future

By John Maxfield - Feb 16, 2014 at 8:00AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

While low interest rates are the bane of banks today, they will be a huge profit driver in the future. Here's why banks like Wells Fargo, Bank of America, and M&T Bank are positioned to benefit more from the inevitable rise in interest rates than their competitors.

If you own bank stocks today, you'll be thanking yourself for years to come. The reason is that depositary institutions like Wells Fargo (WFC -0.79%), Bank of America (BAC -1.71%), and M&T Bank (MTB -0.10%) are primed to earn considerably more money once short-term interest rates increase.

Given the traditional business model of a bank, it's tempting to conclude that the ideal interest rate environment is one in which long-term rates are high and short-term rates are low. This is because banks, as a general rule, generate a considerable portion of revenue from arbitraging interest rates -- that is, borrowing money at low short-term rates and then lending it back out at higher long-term rates.

The problem with this view is that it's somewhat out of date. Take a look at most bank balance sheets today, and you'll find loan books dominated by commercial loans. And commercial loans, in turn, are typically indexed against short-term rates. Added to this, most banks hold a significant amount of noninterest-bearing deposits, which don't become more expensive with a rise in short-term rates.

When you take these things into consideration -- the predominance of commercial loans on bank balance sheets and the inelasticity of noninterest-bearing deposits -- then it becomes clear that the ideal interest rate environment for most banks is one in which both short- and long-term rates are high.

This is something that KeyCorp's chief financial officer Donald Kimble, who recently joined the bank from Huntington Bancshares, discussed in the middle of last October. "While Key, along with other asset-sensitive banks, generally benefit from a rise in both short-term and long-term rates, the duration and characteristics of Key's loan and investment portfolio position us to realize more benefit from a rise in the shorter end of the yield curve."

So, how can you tell whether a specific bank is positioned to benefit more from a future (and inevitable) rise in short- and long-term rates going forward? One way is to compare the proportion of noninterest-bearing deposits they have relatively to total liabilities -- see the table above. The bigger the proportion, the smaller the uptick in funding costs relative to an increase in the earning-asset yield.

By this measure, of the 10 biggest traditional banks in the country, the three that are best primed to benefit from the eventual rise in rates are M&T Bank, Fifth Third Financial, and PNC Financial. Of the big four banks, meanwhile, Wells Fargo and Bank of America comfortably outpace Citigroup and JPMorgan Chase.

Does this mean that these banks will necessarily outperform their counterparts? Not necessarily, as there are a multitude of moving parts that weigh on profitability at multibillion-dollar banks like these. At the same time, however, it's something that investors would be wise to consider when buying bank stocks.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Bank of America Corporation Stock Quote
Bank of America Corporation
BAC
$33.86 (-1.71%) $0.59
Wells Fargo & Company Stock Quote
Wells Fargo & Company
WFC
$41.67 (-0.79%) $0.33
M&T Bank Corporation Stock Quote
M&T Bank Corporation
MTB
$162.73 (-0.10%) $0.16

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
330%
 
S&P 500 Returns
115%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/21/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.