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) 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.

BMO Capital Markets rates Regions "outperform" and on Monday raised its price target for the shares to $13 from $12. Based on Monday's closing price of $9.85, BMO's price target represents 32% upside.

Chan acknowledged that the interest rate sensitivity models used by the banks have limitations, "including assumptions based on a parallel shift (not steepening or flattening) in the yield curve, how quickly assets and liabilities reprice (discussed in further detail later in the report), and the stickiness of deposits in a rising rate environment."

Based on the banks' own analysis, Zions Bancorporation ( ZION) of Salt Lake City sees the greatest benefit from parallel increases in interest rates. If rates rise by 100 basis points, the bank expects its annual net interest income to increase by 8.6%. If rates go up by 200 basis points, Zions expects net interest income to be boosted by 18.1%. Chan rates Zions "outperform," but didn't raise her $33 price target for the shares.

In her "sum of the parts" valuation model for regional bank stocks, Chan assumes the Federal Reserve will begin raising the federal funds rate in mid-2015, with the rate rising by 100 basis points by the end of the year, and by another 100 basis points to 2.00% by the middle of 2016.

Other assumptions include a discount rate of 10%. Chan also expects that investors will "value earnings driven by future interest rate increases at the same multiple as our 2014 forward P/E targets." An additional caveat is that some banks, including Wells Fargo ( WFC), only publicly disclose their interest rate sensitivity calculations annually.

Chan on Monday raised her price target for Wells Fargo by a dollar to $47, while sticking with her "market perform" rating for the stock. The new price target represents potential upside of 9% from Wells Fargo's closing price on Monday of $43.20.

Here are the other six large regional banks for which BMO raised its price targets on Monday, based on their "sum of the parts" rate sensitivity analysis:
  • BMO rates BB&T (BBT) of Winston-Salem, N.C. "market perform" and on Monday raised its price target for the shares to $40 from $38, implying 12% upside from Monday's closing price of $35.57.
  • Comerica (CMA) of Dallas is also rated "market perform" by BMO, which on Monday raised its price target for the shares to $42 from $41.00. Comerica closed at $42.06 on Monday.
  • Chan raised her price target for M&T Bank (MTB) of Buffalo, N.Y., to $124 from $117, while sticking with her "market perform" rating for the shares. The higher price target represents 5% upside from M&T's closing price of $117.82 on Monday. M&T has a deal in place to acquire Hudson City Bancorp (HCBK) of Paramus, N.J., for roughly $4.7 billion in cash and stock. However, Federal Reserve approval of the deal has been delayed as M&T works to address regulatory concerns over its Bank Secrecy Act and anti-money laundering compliance programs. M&T and Hudson City have extended the date after which either party may terminate the merger, to Jan. 31, 2014.
  • For PNC Financial Services Group (PNC) of Pittsburgh, BMO raised its price target to $78 from $76, while sticking with a "market perform" rating. The new target is 2% higher than PNC's closing price of $76.11 on Monday.
  • BMO raised its price target for SunTrust (STI) of Atlanta to $36 from $35, while continuing to rate the shares "market perform." The new target is 3% higher than Monday's closing price of $34.80.
  • For U.S. Bancorp (USB) of Minneapolis, BMO raised its price target by a dollar to $39, representing potential upside of 5% over Monday's closing price of $37.16.

In addition to Zions and Regions, BMO rates two large regional banks "outperform," although Chan didn't raise price targets: Fifth Third Bancorp ( FITB) of Cincinnati, with a price target of $22, and KeyCorp ( KEY) of Cleveland, with a price target of $14.00.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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