As Rates Shoot Higher, Bank Stocks Stand to Reap Big Benefits

After years of scraping along at virtually zero, U.S. interest rates are starting to shoot higher!

One factor is the Federal Reserve. It raised rates in mid-December and signaled to expect three more hikes during 2018. That means we’re entering the familiar “stair step” pattern of steady increases, as you can see here in this chart of the federal funds rate over the last five years:

Another force is rising inflation. That’s the kiss of death for bondholders because it erodes the value of the fixed payments you get from Treasuries. Still another factor more recently is concern that major foreign debtholders like China will stop buying new U.S. bonds – or heaven forbid, start dumping the massive bondholdings they already have.

Regardless of the CAUSE of the rate increases, the EFFECTS can be found everywhere. Two-year yields just topped 2%, the first time since the 2008 credit crisis that forced the Fed down to zero. The five-year Treasury is at its highest since 2011, above 2.3%, and the 10-year is above 2.5%. Bill Gross, the longtime fund manager nicknamed the “Bond King”, is also back in the public eye, declaring on TV that the quarter-century-long bond bull market is dead.

Some are concerned that higher rates will kneecap stocks. But it’s too soon for that. Rates are still historically low.

Plus, it’s important to remember why the Fed is raising rates: Unlike in 2008 when the economy was on its rear end, it’s doing much better now. Unemployment is still very low, hiring is on the mend, and companies just got handed billions of dollars in tax breaks. All that free cash will find its way back into the economy as new hires, raises or other spending, only adding fuel to the fire and making the case for even higher rates.

In other words, stocks of companies with cash on hand, well-managed balance sheets, and solid business models should do fine with higher rates. And banks usually do particularly well in a rising rate environment.

After all, the whole business of banking is marking up the money we deposit by lending it out at higher rates. And if borrowers are confident about the future, they’ll borrow and spend despite higher rates.

So to help you find some promising bank investments, I ran a new screen using the Weiss Rating Stock Screener. The first cut, obviously, was to narrow down the list to the banking industry, and sort it so that the highest quality stocks were at the top.

After that, I looked for banks with at least $5 in cash per share, and price-to-earnings-to-growth (PEG) ratios of less than 0.20.

Cash per share is an indicator of how a bank might pay its immediate bills. It counts short-term, liquid investments and cash, and divides that number by shares outstanding. The upshot is that as money gets more expensive, a bank with cash on hand isn’t beholden to borrowing to keep the enterprise steady.

The PEG ratio is a way of figuring out what investors will pay for growth. A standard P/E ratio alone shows you that calculation right now; adding in earnings growth gives you a glimpse into the future.

With a PEG ratio, lower than 1 is better. So, I screened for banks that fell into the lowest quintile of this measure, under 0.20. This is what my resulting Screener looked like:

                                                                                                Data Date: 1/12/2018

SI Financial Group, Inc. (SIFI, Rated “B+”) is the holding company of Savings Institute Bank and Trust Company, a 25-branch lender in Connecticut and Rhode Island. It does mortgage and commercial lending, home equity lending, traditional banking, and wealth management.

The bank stock hasn’t done much recently, with a flat performance over the past year. But its three-year return is a much more promising 38.6%. Meanwhile, return on equity over two years has been around 8%, well above the industry average of 2.8%.

The $7.68 per share, in cash on hand and PEG of 0.12 suggest a bank that has been unjustly ignored by investors despite a solid cash position and good prospects for the months ahead, whatever happens with rates.

Bank of Commerce Holdings (BOCH, Rated “A-”) is a California retail and commercial bank based in Redding. It has nine offices in the northern part of the state. Like SIFI, this bank seems to have lagged over the past 12 months, returning just 1.8% to investors.

But it has shined over the past five years, with a glowing 172.6% total return. Meanwhile, return on equity is 8.7% and the bank sports a profit margin of 21.8%. It has plenty of cash on hand to weather rate changes, north of $5 per share, and a PEG ratio of 0.19 points to growth at a very reasonable price for investors today.

Bottom line: With interest rates really starting to perk up, bank stocks look even more attractive. So be sure you use our Weiss Ratings Stock Screener to search for good places to invest in the sector. It’s a valuable benefit available to our Weiss Ratings Platinum subscribers.

Think Safety,

Gavin Magor