Interest rates have pushed up stock price valuations. This is not a new trend. Interest rates have trended downward over the last 30 years. But the declining interest rate "super cycle" may be coming to a close. Interest rates are near historical lows. There is simply nowhere for them to go but up. The Federal Reserve continues to hint that it will raise its federal funds rate target.
When interest rates rise, many stock prices may fall. But not all stocks will respond the same to rising rates. Some will actually benefit from rising rates. One specific industry stands to benefit from rising rates: regional banks.
Regional banks are likely to be major winners if the Federal Reserve raises interest rates this year. That's because banks stand to earn more interest on the loans they make. And, since the interest they pay on short-term deposits would rise at a slower rate relative to the increase in interest they earn, higher rates are a net positive for bank profitability.
The Fed raised rates once last year, and expectations are for the central bank to do so again in 2016. The next interest rate hike could come as early as this month. The policy-setting Federal Open Market Committee plans to meet on Sept. 20 and Sept. 21.
Now let's look at four regional banking stocks that are attractive. They're all high-quality dividend growth stocks. One is a Dividend Achiever (a group of 274 stocks with 10-plus years consecutive dividend increases). You can see all 274 Dividend Achievers here. Another has paid steady or rising dividends for more than 100 years. Keep reading to learn more about these quality regional banks.
KeyCorp can trace its history back to 1825, when New York Governor DeWitt Clinton signed legislation chartering the Commercial Bank of Albany, the predecessor of KeyBank.
The company has grown significantly since that time. Today, KeyCorp has a market capitalization of $13.13 billion and has generated $835 million in net income over the last 12 months, according to data at Morningstar.
Businesses with a long corporate history have proven they can stand the test of time. KeyCorp's 191 years of operating history show the company can survive a wide range of different economic environments. The idea that a business' history shows it is more likely to be around in the future is explored in the Lindy Effect.
The prolonged period of historically low interest rates over the past several years has kept KeyCorp from growing earnings at higher rates, but the company still managed to record adjusted earnings per share of 27 cents in the second quarter, in line with the year-earlier adjusted EPS. Revenue was also stable from the year-earlier quarter and grew 3% sequentially from the first quarter.
KeyCorp is looking to acquisitions to drive growth until interest rates climb. In July, it completed its acquisition of First Niagara Financial.
Plus, KeyCorp is an aggressive dividend growth stock. It raised its shareholder payout by 13% this year, and upon passing the Fed's annual stress test, approved an initial plan to raise its dividend another 11% next year.
KeyCorp stock offers a 2.8% dividend yield, and the stock has an attractive valuation as well. KeyCorp trades for a price-to-earnings ratio of 12.8, based on earnings over the past 12 months. It has a P/E of 10 based on estimated earnings for the next year. These ratios make it much cheaper than the S&P 500 index, which has a trailing P/E of 25 and a forward P/E of 19.
Fifth Third has, like other banks, faced a challenge in the form of low interest rates. You can see this impact on its net interest income, which fell 1.3% in 2015 to $3.55 billion from $3.60 billion in 2014.
Until rates rise, it is looking to acquire growth through mergers and acquisitions. And this has helped Fifth Third. For 2015, the bank reported net income of $1.7 billion, up 16% from $1.5 billion in 2014.
So far, This year, that strategy has worked well, too. In the second quarter, Fifth Third had 11% year-over-year growth in earnings per share. Growth was partly due to 4% year-over-year growth in return on average assets.
Another factor boosting Fifth Third's earnings is its aggressive share repurchase program. Last quarter, the company reduced its share count by 5% vs. the same quarter the year before.
There are signs that the Fed's decision last December to raise interest rates has already had a positive effect on banks like Fifth Third. In the second quarter, the company's total interest income rose 4% year over year, which the company specifically attributed to last year's interest rate hike.
Plus, the company is seeing strong growth in deposits and other short-term assets, as consumers are saving more with the improving economy. Last quarter, Fifth Third's average securities and other short-term investments rose 4.6% from the same quarter last year.
Fifth Third is also seeing robust loan demand, particularly in the areas of commercial loans and consumer mortgages. This led to a 2% year-over-year increase in average loan balances last quarter.
Fifth Third has the lowest valuation on this list; shares trade at a price-to-earnings ratio of 9.9, which is less than half the valuation multiple of the S&P 500. And, the stock offers a 2.6% dividend yield.
BB&T has paid dividends to shareholders each year without interruption since 1903. That's a streak of more than 100 years of steady dividends.
As is the case for many regional banks, BB&T's growth has declined in recent years because of persistently low interest rates. BB&T's earnings per share decreased by 5.8% last year. However, the company realized 4.9% growth in revenue for the year, thanks to acquisitions.
BB&T's purchase of Bank of Kentucky Financial and Susquehanna Bancshares fueled its revenue growth last year. They also have propelled the company to even greater heights so far in 2016. Last quarter, BB&T generated 18% revenue growth and 19% net income growth. Revenue hit a record for the company.
This growth came even though BB&T's net interest margin declined another two basis points last quarter. Fortunately, declining interest margins is being more than offset by organic growth from new deposits and loans, as well as the impact of acquisitions.
Average loans rose 5% last quarter to $141 billion, while average deposits grew 6.9% to $160.3 billion.
BB&T has a high-quality loan portfolio. It ended last quarter with a 10% common equity Tier 1 ratio, and just a 0.28% net-charge off ratio as a percentage of average loans.
BB&T is a very strong dividend stock, because of its above-average yield and high rate of dividend growth each year. The stock provides a 3.2% dividend yield, which is a full percentage point higher than the average dividend yield in the S&P 500.
BB&T passed this year's stress tests, which gave the company the go-ahead to increase its capital returns to shareholders. BB&% did not disappoint; the company increased its dividend 7% and approved a $640 million share repurchase authorization.
Community Bank may not be a household name among bank stocks, but it deserves much more attention than it gets because of its long track record of strong returns for shareholders. For example, the stock has delivered nearly 40% total returns to shareholders over the past one year including dividends.
And, Community Bank has increased its dividend for 24 years in a row. It recently raised its dividend again by 3%. Assuming the company raises its dividend again next year, it will qualify as a Dividend Aristocrat in a year. It is currently a Dividend Achiever.
The company maintains its impressive streak of dividend growth thanks to its highly profitable business and growth from acquisitions.
Community Bank has more than $8 billion in total assets and serves customers in New York and Pennsylvania. Its focus on commercial and consumer banking has resulted in steady growth for many years. Over the past three years, book value and earnings per share increased 24% and 22%, respectively.
Last year, Community Bank's earnings per share dipped 1%, but the company still earned $2.19 per share. The decline was due to its acquisition of Oneida Financial, but excluding acquisition costs, the company's adjusted EPS grew 2% year over year.
Going forward, the acquisition should help the company continue to grow earnings because it gives the company diversification into other businesses outside its core focus, primarily insurance and wealth management.
The acquisition drove 57% revenue growth in those two areas last quarter.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.