Regional bank stocks could be the big winners in 2021 as rates rise, economy rebounds

Published Fri, Mar 12 20211:18 PM EST

Key Points

The benchmark 10-year Treasury yield has been rapidly rising in the last month, spurring inflation worries among investors.
Rising Treasury yields have spooked stock investors in recent weeks, but analysts say banks are poised to do well.
Steepening yield curves – the difference between short-term and longer-term rates – boost banks’ profitability.

Regional banks' stocks are emerging as winners in a world of rising interest rates, analysts said. Investors have been anxious that the hotly debated $1.9 trillion stimulus, which President Joe Biden signed on Thursday afternoon , could help overheat the economy and result in higher interest rates. Those fears led the 10-year Treasury to reach a new high above 1.6% on Friday and the stock market declined as technology shares fell. Not all stocks will face a drubbing when interest rates inch up, however. Analysts believe that regional banks could be standout performers under those circumstances. Indeed, the SPDR S & P regional banking ETF is up about 37% year-to-date – significantly outperforming the S & P 500 for the period. The fund, which counts SVB Financial Group and Fifth Third Bancorp among its holdings, rose about 2% on Friday. "Given our base case view that yields continue to move higher from here, our analysis would suggest that banks still have further room to run," said Ken A. Zerbe, equity analyst at Morgan Stanley in a March 8 research note. In this research note, Morgan Stanley highlighted 10 months with the highest increases in the 10-year Treasury yield going back to 2010. The chart below depicts how midcap banks performed during those times. The bank found that during each of those months, midcap banks outperformed the S & P 500 every time, with the sector beating the index by an average of 650 basis points or 6.5%. One basis point is equal to 0.01%. "It's really no surprise that the banks do well when the 10-year [Treasury yield] is rising," wrote Zerbe. "A steeper yield curve is almost always good for the midcap banks," he said. The yield curve is the difference between short-term and longer-term interest rates. A steeper curve helps banks' profitability because they can borrow at the low short-term rates and then lend at the higher long-term rate. Rising inflation expectations not only signal an improving economy, but also bode well for banks' reinvestment rates – the money they earn from reinvesting maturing bonds at higher rates, Zerbe noted. Morgan Stanley's base case forecasts that the Federal Reserve will hike rates for the first time in the third quarter of 2023. Highly favored while rates rise Regional banks getting the nod from analysts include Fifth Third Bank and First Republic Bank. Bank of America analyst Erika Najarian rated both firms a "buy," setting a price objective of $39 for Fifth Third and $177 for First Republic. Fifth Third, which closed at $38.01 on Thursday, is up 42% for the year. First Republic, which was $171.03 at market close yesterday, is up about 18% for 2021. For investors in search of individual names, these three regional bank stocks have the most favorable ratings among Wall Street analysts, according to FactSet. The shares also have some upside remaining before they reach their average 12-month analyst price target. Further, Goldman Sachs recently highlighted Signature Bank of New York as one of the institutions that would benefit the most from a steepening yield curve – the difference between short-term and longer-term rates. Goldman also added Fifth Third to its conviction list, citing it as a "'cheap' way to play rate upside optionality with limited downside in a low rate scenario (-5.5%) and significant upside (+50.5%) if higher rates do come through."

Fifth Third Bank

Luke Sharrett | Bloomberg | Getty Images

Regional banks' stocks are emerging as winners in a world of rising interest rates, analysts said.

Investors have been anxious that the hotly debated $1.9 trillion stimulus, which President Joe Biden signed on Thursday afternoon, could help overheat the economy and result in higher interest rates.

Those fears led the 10-year Treasury to reach a new high above 1.6% on Friday and the stock market declined as technology shares fell.

Not all stocks will face a drubbing when interest rates inch up, however. Analysts believe that regional banks could be standout performers under those circumstances.

Indeed, the SPDR S&P regional banking ETF is up about 37% year-to-date – significantly outperforming the S&P 500 for the period. The fund, which counts SVB Financial Group and Fifth Third Bancorp among its holdings, rose about 2% on Friday.

"Given our base case view that yields continue to move higher from here, our analysis would suggest that banks still have further room to run," said Ken A. Zerbe, equity analyst at Morgan Stanley in a March 8 research note.