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Regional Banks Are Ready For the ‘Taper’

14 September 2013 in Trading Ideas

As speculation increases that the Federal Reserve is poised to shrink the size of its bond-buying program in the wake of a slowly improving US economy,1 the impact on various investment classes has been noteworthy. For example, stocks slumped but lately have found new life, while gold prices which had found new life only a month ago, but more recently has seen prices slump.

Interest rates, however, have appeared a little more purposeful, directionally speaking, with the yield on the 10-year Treasury note rising 120 basis points in the past three months alone. For many investors, that trend will only continue once the Fed eases bond purchases.

How a possible continued rise in interest rates will affect stocks is a vexing question for investors. But an easier road for traders could be to consider specific equity sectors that might get more of a direct boost from the Fed’s anticipated taper.

A new alternative in that vein is our latest Fed Tapering motif, a portfolio of stocks of regional banks which could stand to benefit if interest rates push higher.

Why regional banks? In theory, these smaller banks are generally more heavily funded by core deposits, particularly when compared with the country’s “Too Big to Fail” mega-cap banks, and carry a larger percentage of short-term loans on their books. Higher interest rates can mean more net interest income for regional banks with a less diversified revenue stream.

Of course, this doesn’t mean that a continued rise interest rates is only a good thing. Higher rates equate to a higher lending/borrowing costs, and it’s conceivable that at some higher-rate tipping point, increases in net interest income would be offset by consumers pursuing fewer loans and mortgage refinancings, both of which can be key business sectors for regional banks.

However, for investors who are more confident in the current economic recovery and are considering an equity portfolio tied to the Fed’s eventual retrenchment, this new motif could be worth a look.

1Phil Izzo, “Economists Expect Tapering Announcement Next Week,” WSJ.com, Sept. 12, 2013.