Fed Hikes Rates, Banks Stand Strong: Here’s Why (and Which are “BUYs”)

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After much debate and anticipation, the Federal Reserve finally hiked interest rates again last week. It raised the benchmark short-term rate to a range of 0.50% - 0.75% from the previous range of 0.25%-0.50%. The Fed also hinted at several more rate hikes in 2017.

The move caused the dollar to gain strength against the euro, the British pound to decline again, Treasury bond yields to rise, and gold prices to fall. But what effect will the rate hike have on U.S. banks – both the underlying institutions and their publicly traded shares?

First, interest rate fluctuations can result in a potential loss for a bank if it does a poor job matching its rate-sensitive assets, including loans and investments, to its rate-sensitive liabilities, including deposits and other borrowings. A one-year “GAP ratio” is helpful in indicating whether a bank can handle an interest rate change without losing money, or whether it will actually benefit from such a change.

Banks with a negative gap ratio have a disadvantage in an increasing interest rate environment. That’s because their liabilities scheduled to reprice within one year are greater than their assets scheduled to reprice within one year. Banks in this situation will see their cost of borrowing and deposits rise more quickly than their income on loans and investments, something that puts pressure on profits.

The opposite is true for banks with a positive gap ratio. And the more positive the ratio, the better positioned they are to profit from rising interest rates.

The good news for banks (and bank stock investors) right now? Our bank data analysis indicates that most large banks in the U.S. are set to gain from the Fed’s rate increase. Out of 101 banks with assets of $10 billion or more, only five reported a negative one-year GAP ratio in the most recent quarter. The rest appear to be in good shape, with positive GAP ratios.

Here is a table showing banks with the highest one-year GAP ratios. We’ve included the bank name, the bank’s total assets, its one-year gap ratio, and the Weiss Safety Rating for the underlying bank. We’ve also given you the parent company’s stock ticker symbol, the rating on the parent’s shares, and its year-to-date percentage change. No surprise that the numbers are fairly strong – with gains of up to 65.6%.

The main exceptions? Banks whose parent companies are foreign institutions. For instance, Deutsche Bank of Germany and Barclays Bank of the U.K. have other, bigger problems related to currency movements, the Brexit vote, derivatives losses, and gigantic mortgage and market-manipulation settlements.

Meanwhile, if you look at this table showing those five banks with negative one-year GAP ratios, you’ll see that none of these negative GAP ratios are significant. That means the banks should be able to adjust their portfolios so they better match assets and liabilities. As a result, their shares have also performed fairly well.

Bottom line: Our proprietary Weiss Ratings data shows that many U.S. banks are well-positioned to benefit from Fed rate hikes, rather than get hurt by them. So you may want to consider U.S.-based banks whose parent companies have strong Weiss Ratings as investments for your portfolio.