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The Deal: Banks Poised to Benefit from Higher Rates

NEW YORK ( TheDeal) -- Banks face a brighter outlook against a backdrop of rising rates, yet the impact will vary widely among lenders, analysts warn.

Federal Reserve Chairman Ben Bernanke said Wednesday he foresaw a moderation in the pace of the Fed's asset purchases later this year, eventually ending in mid-2014 when unemployment is likely to be around 7%.

Using the analogy of driving, he likened it to taking pressure off the gas pedal as the economy picked up speed rather than applying brakes by raising official interest rates -- noting 14 of the Fed's 19 board members expected the first rate rise in 2015.

"The fundamentals look a little better to us -- in particular, the housing sector which has been a drag on growth, with the rise in prices creating construction jobs, helping consumer spending and sentiment," Bernanke told reporters at a press conference. "State and local governments no longer have to lay off workers and generally financial conditions are improving."

Bernanke said the main drag on growth was tighter federal fiscal policy and stressed that the Fed's asset purchase plans were tied to economic improvement.

Major bank stocks had mixed performance on Wednesday, a scenario that analysts said will be reflected when interest rates rise.

Goldman, Sachs & Co. analyst Richard Ramsden noted that despite debate on the timing of official interest rate hikes, they had already begun to be priced in by markets.

He pointed out that rate-sensitive banks had gained 25% for the year to date, versus gains of up to 17% for other banks, and against a 15% rise for the S&P 500. Bank of America Merrill Lynch has gained about 38%, while Wells Fargo Bank NA has gained 19%.

Futures markets also imply 25 to 50 basis points of hikes in 2015, while many banks have margin expansion baked into their estimates, Ramsden noted.

A rising interest rate environment is a broad positive for banks in that it signals a recovering economy where consumer and business confidence is higher, with banks likely to write more loans at fatter margins. Yet the mix of bank portfolios is key -- those with large mortgage books locked in at low long-term rates will suffer as their funding costs rise but the return on their loans falls.
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