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5 bank stocks to buy as rates rise
Inflation seems a distant threat, so the Fed likely will raise rates at a measured pace for the rest of the year. This makes it a good time to buy banks in high-growth regions.
By Jim Jubak
Slowly rising interest rates and modest economic growth usually mean pretty good times for banks and bank stocks. Banks, after all, are adept at increasing the interest rates that borrowers pay on credit cards, adjustable mortgages and business loans faster than they increase the interest they pay to depositors on savings accounts and certificates of deposit.
Banks located in regions that are growing faster than the national average can do better than pretty good. Higher-than-average economic growth translates into faster-than-average growth in loan demand and customer deposits. Consumer deposits are especially important in times of rising interest rates because they're the cheapest source of new money for banks with growing loan portfolios.
The worry, of course, is that national economic growth will race ahead so quickly that it fuels fears of runaway inflation. This in turn could cause the Federal Reserve to raise interest rates sharply as it struggles to prevent inflation from gaining traction. Repeated interest rate increases that add up to a big boost over a short period arent good for bank profits. It can dry up lending, and, even worse in the short run, force banks to take write-downs on their existing portfolios of bonds and mortgage-backed securities since they fall in value as rates rise. Worries that this might happen can be enough knock down bank stocks.
Fretting over interest rates
And that's exactly what happened from March through August as investors worried not only that the Fed would raise rates but also would raise them faster than banks could handle. From March 5, through Aug. 9, the Philadelphia/KBW Bank Sector Index dropped 8%.
But its the retreat of those worries that has helped the banking sector reverse course since Aug. 9. From then through Sept. 7, the index rose 7%. With the economy growing at about 3%, instead of the 7% growth rate of the third quarter of 2003, inflation seems a more distant threat. While Wall Street still believes that interest rates are headed up for the rest of the year, the consensus isnt looking for anything worse than measured moves from the Fed as Alan Greenspan & Co. nudge real interest rates (thats interest rates after subtracting inflation) back above zero.
This all makes it a good time to look for shares of banks in high-growth regions, which means targeting the Sun Belt and fast-growing (and wealthy) suburban areas. (For more on why it makes sense to invest in wealth banks, see my July 30 column.) It certainly doesnt hurt to make sure that these banks have a track record of successfully growing deposits and solid franchises that make them dominant in their geographic niche.
Here are the three stocks I recommended in my 11:20 a.m. ET. Wednesday appearance on CNBCs "Morning Call."
A rising discount creates opportunity
Trustmark (TRMK, news, msgs). On a historical basis, Trustmark is cheap. The stock usually trades at a 5% discount to its small bank peers, and now that discount is up to 14%, J.P. Morgan calculates. This is partly a reflection of the relatively low yields that this conservative Mississippi bank earns on its portfolio and partly a reflection of Wall Streets belief that Trustmark does business in a slow growth market.
Well, that low-yielding portfolio is also a low-risk portfolio in times when interest rates are climbing. In addition, in spite of what Wall Street believes, Trustmark somehow has managed to generate compound average annual earnings growth of 13% over the last five years when its peers have produced 9% growth. Key to that extra earnings growth is the banks extraordinary profitability: 15% to 17% a year over the last three years versus 13% to 15% at comparable banks.
Main Street Banks (MSBK, news, msgs). I named Main Street Banks as one of my stocks in waiting in my Aug. 20 column, 10 best stocks for the rest of 2004. With worries about quick and large interest rate increases receding, the wait is over. As the dominant franchise in Atlantas suburbs, Main Street bank has been able to grow loans faster than its small bank peers.
It also certainly doesnt hurt that Wachovia's (WB, news, msgs) pending acquisition of SouthTrust (SOTR, news, msgs) will create turmoil in the Atlanta market that will work to Main Street's advantage. Even before the deal, the bank has been successful at attracting loans from SouthTrust and Wachovia. Loan balances grew by 21% (annualized) from the end of 2003 through the end of June 2004. Raymond James forecasts earnings growth of 15% in 2005, up from a projected 13% in 2004.
First Oak Brook Bancshares (FOBB, news, msgs) is the smallest of these first three banks with a market capitalization of $295 million, but it does business in some of Chicago's wealthiest suburbs. In the second quarter, total deposits climbed by 9% to $1.7 billion and total loans climbed by 29%. Importantly for the banks margins, the net charge-off for loans as a percentage of all loans fell to just 0.03%. Fee income, what a bank earns from services that range from returning a bad check to managing a family trust, climbed by 5% from the previous quarter.
Two exclusive picks for CNBC.com on MSN
Middleburg Financial (MBRG, news, msgs). This bank has a market capitalization that, at $127 million, is even smaller than First Oak Brook's. But Middleburg Financial essentially duplicates the Illinois banks business model in the wealthy Virginia horse country south of Washington, D.C. You wont find a lot of Wall Street analysts following a bank stock this small. The one earnings estimate reported by Zacks Investment Research is calling for 16% earnings growth in 2005. The stock sells for 17.3 times trailing earnings per share.
Bank of Marin (BMRC, news, msgs). This is a West Coast version of the wealth-bank model, this time across the Golden Gate Bridge from San Francisco. On July 15, Bank of Marin reported record earnings of $2.3 million for the second quarter, a 25% increase from a year earlier. Total loans were up 17% and total deposits increased by 19%.
By the way, the loan pipeline, which has been building since the fourth quarter, is now at a record high and the bank projects above-average loan growth for the year's second half. The loan portfolio didn't contain a single nonperforming loan at the time of this report, and net charge-offs for bad loans total less than $70,000 for 2004 to date. Non-interest income grew by 33% in the years first six months.
Dont expect bank stocks like this to zoom upward. For that youll have to wait for the next technology rally, whenever that is. But if youre looking to beat the indexes with less than market risk and think the economy will grow modestly, these five bank stocks deserve a look.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares in any of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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