Prior to the very recent threat of US strikes against the Syrian government over the last two weeks, the mere mention of the word “taper” was enough to send investors into a panic.
Among the various reasons for concern about the end of the Federal Reserve’s Quantitative Easing program, now on its third go-around, are the potential consequences of higher interest rates. One of the most controversial aspects of QE has been the maintaining of interest rates at historically low, almost non-existent levels, in an ostensible effort to facilitate spending and jumpstart economic activity.
But while this situation has been favorable to large financial institutions such as JPMorgan Chase (JPM) and Bank of America (BAC) , who are involved in all aspects of the banking business, it has actually put the squeeze on smaller commercial banks.
Indeed, a steeper yield curve is desirable for smaller financial institutions whose primary concern is with commercial banking- holding deposits, and lending money, as it typically means higher profit margins resulting from a larger spread between the cost of short-term deposits on the one hand and the yields from long-term investment and lending, on the other.
On Tuesday, this upside of higher rates was spotlighted by regional banks such as Fifth Third Bancorp (FITB) , BB&T Corp. (BBT) and M&T Bank Corp. ($MTB), who quite overtly advocated for the Federal Reserve to let interest rates go up. Fifth Third CEO Kevin Kabat, as well as BB&T’s Kelly King both reminded investors in attendance at a conference in New York that while the biggest lenders are vulnerable to markdowns of securities, regional banks can benefit from their ownership of government debt.
It is possible that smaller-sized banks have rallied in the second half of the year, outperforming their larger peers, based on the expectation of rising rates. As reported by Bloomberg, the KBW Bank Index that tracks the performance of the 24 biggest financial institutions has gained just shy of 3 percent this year. Meanwhile, the KBW Regional Banking Index is besting that by a factor of almost two, up nearly 5 percent.
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