Banks release information every quarter on how changing rates might affect their net interest income (NII), but rate sensitivity isn’t consistently priced into their stocks. To some extent this is because rate sensitivity calculations aren’t completely uniform across the sector, but negative headlines that shift investor attention away from basics like NII also plays a role, giving investors the potential for outperformance if rates do go up next year.
Not all bank stocks reflect asset sensitivity
“Why does CMA get credit for rate sensitivity when Bank of America Corp (NYSE:BAC) does not?” ask Bernstein Research senior analysts Kevin St. Pierre and John E. McDonald. “Clearly the CMA story has been easier to tell (and follow). Sit back and rates will eventually save the day… At banks like Bank of America and JPMorgan Chase & Co. (NYSE:JPM), investors have been too distracted with concerns about the difficult FICC trading environment, elevated legal costs, and ongoing regulatory burdens to focus on the potential benefits of rising rates.”
To figure out who is getting credit for rate sensitivity, they take banks’ rate sensitivity levels as a given (though they warn that they aren’t exactly equivalent) and normalize them to reflect a 200bp rise in rates, estimate 2015 EPS based on the new rate, and then calculate PE on forward earnings.
Rate sensitivity: Large caps have the most to gain from a rate hike
Large cap banks have lower multiples in general, but the range is still pretty striking (7.8x – 18.1x) and the country’s largest banks have more to gain, with an expected 18% EPS increase compared to the top 50 average of 11%. But some banks have done a better job explaining why their assets will benefit from higher rates, causing their share prices to reflect a best case scenario where interest rates go up and the bank is able to capitalize on them as much as they hope. St. Pierre and McDonald identify Comerica Incorporated (NYSE:CMA) and Zions Bancorporation (NASDAQ:ZION), both rated Underperform, as two midcaps that have especially full valuations relative to their asset sensitivity.
They argue that as “distractions” wane and rates go up Citigroup Inc. (NYSE:C), JPMorgan Chase & Co. (NYSE:JPM), and Wells Fargo & Co (NYSE:WFC), all of which they rate Outperform, will likely have both multiple expansion and increased earnings. There is plenty of disagreement about what the end of QE and monetary accommodation will look like, and not everyone expects rates to go back to the ‘normal’ levels we’ve become accustomed to, but investors worried about a rate hike will impact their portfolios should consider including banks that are ready to benefit from it.