Rate Hike in the Cards? 2 Banking Picks - Analyst Blog

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Fed Chair Janet Yellen's first press conference was possibly the most widely expected event this month. Its outcome, however, leaves much to be desired. Following her statements, all three indexes fell and the CBOE Volatility Index surged upwards.

Unemployment and the Rate Hike

The immediate question lurking in the minds of investors was an outcome of jobs data released this month. The unemployment rate is now at 6.7%, very close to the 6.5% Fed target. The Federal Open Market Committee (FOMC) had said in December 2012 that it would not even think of increasing the federal funds rate until this was achieved. At the time, unemployment was at 7.8%.

Naturally, investors wanted to know what route the Fed would take going forward. In other words, they were keen to know when the Central Bank would begin hiking the rate. According to the FOMC statement released yesterday: "It likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends."

Yellen Clarifies

Yellen explained that going forward the Fed's assessment of economic conditions would be qualitative. This is possibly a more prudent course, since the decline in unemployment rate may not have taken into account other factors such as people dropping out of the workforce voluntarily.

But the markets reacted sharply to another reply from the Fed Chair. When asked to clarify what the Fed thought was a "a considerable time," she said: "You know, this is the kind of term it's hard to define, but... it probably means something on the order of around six months or that type of thing."

The Impact on Banking

Markets fell following this comment, probably because investors had not expected that the Fed was considering raising the rate that quickly. Banks, on the other hand, may not be averse to a rate hike. Even though a lower interest rate environment has reduced borrowing costs, it has also hit the amount they can charge customers for loans as well as other financial products.

Consequently, the net interest margin for banks has dipped, affecting revenue and earnings. In case of a rate hike, banks will try to charge a higher amount on loans than what it pays out on deposits. However, as the Fed has reduced its bond purchases, Treasury yields have appreciated which have adversely affected the bond portfolios of banks. New fiduciary norms arising out of the Dodd-Frank act have also hit the revenue of banks.

Challenges Ahead

Retail banking has been affected in a completely different way. Checking accounts are now a safe haven for customers. These hold large amounts of idle cash which pay little interest. As the key rate is hiked, customers will look for avenues which pay better returns. This cash will then flow into interest paying accounts. Given such a scenario, embracing new technological solutions is the only way in which banks can remain ahead of the curve.

It is clear that only banks which have the ability to adapt to new regulatory norms and adopt new technological challenges stand to profit from these changes. Strong balance sheets and good past performance are more obvious prerequisites.

Below we present two banking stocks with impressive track records, each of which also has a good Zacks rank.

Comerica Incorporated

Comerica Incorporated ( CMA ) has three major business divisions. These are business and retail banking and wealth management. The company reported fourth-quarter 2013 earnings per share of 77 cents, beating the Zacks Consensus Estimate of 74 cents. With the rise in revenues, on the whole, the credit quality has also improved. Additionally, the company hiked its common stock quarterly dividend.

Comerica Incorporated holds a Zacks Rank #2 (Buy) and has expected earnings growth of 0.50% for the current financial year. At 7.80% growth estimate for the next year is more favorable. The forward price-to-earnings Ratios (P/E) for the current financial year (F1) is 16.74.

Wells Fargo & Company

Wells Fargo & Company ( WFC ) has three business segments. These are wholesale, wealth and community banking. The company earned $1.00 per share in fourth-quarter 2013, thereby achieving earnings growth for the sixteenth consecutive quarter. The reported figure also beat the Zacks Consensus Estimate by 2 cents. Additionally, Wells Fargo announced consecutive dividend increases over the past few years with the latest hike of 20% being announced in Apr 2013.

Currently the company holds a Zacks Rank #2 (Buy) and has expected earnings growth of 3.60% for the current financial year. In this case as well, growth estimate of 5.50% for the next year is more favorable. It has a P/E (F1) of 12.01.

Policy changes may have a partially unwelcome impact, but some banks may be better placed to cope with these challenges. These stocks, in particular, would make additions to your portfolio.

COMERICA INC (CMA): Free Stock Analysis Report

WELLS FARGO-NEW (WFC): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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