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2 Banks to Benefit the Most From a Steeper Yield Curve

NEW YORK ( TheStreet) -- Despite the best efforts of the Federal Reserve, long-term interest rates are rising, which can greatly benefit some banks over the short term.

But with short-term rates likely to stay put for quite some time, investors need to consider the balance-sheet structure of a bank before assuming a benefit to earnings from the current steepening of the yield curve.

The central bank has kept its target short-term federal funds rate in a range of zero to 0.25% since late 2008, and has also been doing what it can to hold short-term rates down. The Federal Open Market Committee continues to say that the federal funds rate is not likely to be raised until the U.S. unemployment rate drops below 6.5%. With the unemployment rate rising slightly January to 7.9%, it seems unlikely that the Fed will make a move on short-term rates this year. Meanwhile, the Fed is continuing to expand its balance sheet in order to hold long-term rates low.

But investors have been anticipating the Fed's eventual reversal of course, pushing the market yield on 10-year U.S. Treasury bonds up by roughly 40 basis points to 2% over the past two months. Meanwhile, the market rate for 5-year Treasury paper has increased by 24 basis points to 0.84%.

"The fixed-income markets usually anticipate the eventual Fed moves and begin to adjust at least a year ahead of the initial Fed actions," according to Guggenheim Securities analyst Marty Mosby.

Most of the large regional banks have been seeing a steady narrowing of net interest margins (NIM) over the past two years, as their assets continue to reprice at lower interest rates. Despite the margin squeeze, a number of regional players have achieved sufficient loan growth to limit the decline of net interest income.

Mosby said in a report on Thursday that "the recent uptick in long-term interest rates has whetted the appetites of bank investors for the grand prize: rising interest rates." That would mean a traditional increase in all interest rates, following action by the Federal Reserve to raise the federal funds rate.

"The traditional rising-rate scenario is a parallel shift in all interest rates along the yield curve. This type of rate rise should benefit the most asset-sensitive banks that are extremely mismatched," Mosby wrote. In a rising-rate scenario, the banks with loans and securities investments maturing or repricing faster than their deposits and borrowings, have the most to gain over the short term.
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