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BMO Lifts Bank Stock Targets, Sees Fed Rate Rise

NEW YORK ( TheStreet) -- It's time for the market to bake a rise in short-term interest rates into regional bank stocks' prices, according to BMO Capital Markets analyst Lana Chan.

"Given the implied probability that short-term rates will begin moving higher by mid-2015, we are raising most of our price targets to reflect a 100 bp increase in rates, discounted back by two years," Chan wrote in a note to clients on Monday.

BMO raised price targets for eight large U.S. regional banks.

The Federal Reserve has kept the short-term federal funds rate in a range of zero to 0.25% since late 2008. Most banks saw the bulk of benefits from a reduction in funding costs years ago, but have continued to see a downward repricing of assets, leading to narrower net interest margins.

The Fed has also been making monthly purchases of $40 billion in long-term mortgage-backed securities and $45 billion in long-term securities since last September. This policy is part of what is known as "QE3," and was meant to hold long-term rates down as well.

The Federal Open Market Committee has repeatedly stated that it "highly accommodative" policy for the federal funds rate was likely to remain appropriate at least until the U.S. unemployment rate dropped below 6.5%. The unemployment rate for July was 7.4%, improving from 7.6% in June.

Investors have been anticipating a tapering of the Fed's bond purchases, sending the market yield on 10-year U.S. Treasury bonds up to 2.61% on Tuesday from 1.70% at the end of April.

So the yield curve is steepening, but most banks have yet to see much benefit from this. What the banks really want is a "parallel" rise in rates, which can only happen when the federal funds rate is raised.

Most large banks include interest rate sensitivity analyses in their quarterly reports. For example, Regions Financial (RF - Get Report) of Birmingham, Ala., in its second-quarter 10-Q filing with the Securities and Exchange Commission said a gradual parallel increase in interest rates of 100 basis points would increase its annual net interest income by $143 million, while a gradual parallel rise in rates of 200 basis points would increase net interest income by $260 million.

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