ABA Banking Journal - September/October 2015 - (Page 44)

> INVESTOR PERSPECTIVE 'smID' BANKs BAcK IN FAVOr: what to make of the rally bY cHrIstopHer mcGrAttY NeArlY seVeN YeArs since the federal funds rate was effectively cut to zero, it is widely believed that interest rates are set to slowly move higher later this year. Whether the inaugural 25 basis point move-up occurs in September or December, timing is now being measured in months, not years. This expectation for rates-both absolute yields and the shape of the yield curve-remains a driving factor in the performance of small and mid-cap (SMID) banks, stalling the rally in Q1 when rates fell and the curve flattened and subsequently reigniting interest in Q2 when this trend reversed. At mid-year, the KBW Nasdaq Regional Bank Index (KRX)-our proxy for small and midcap bank performance-was up 10 percent in 2015 compared to just a 3 percent move-up in the S&P 500. 44 ABA BANKING JOURNAL | sEpTEmBEr/OcTOBEr 2015 To us, this renewed enthusiasm reflects the anticipated benefit on net interest margins from higher rates, which remains the primary driver of bank profitability today. That being said, although the group is seemingly back in favor again, we are also respectful of the longterm correlation of bank stock performance and the direction of consensus forward estimate revisions, which this year have fallen by about 3 percent for the KRX versus a 10 percent move up in SMID-cap bank stocks. The result of this divergence has been fairly significant multiple expansion for the group since the start of the year (15.0x versus 13.6x), most notably for banks with above-average growth characteristics and/or those with asset sensitive balance sheets-two investment themes that remain in favor. This development over the past six months has pushed the KRX's forward P/E above its long-term average (15x versus 14x), leading many investors to question whether this multiple expansion is warranted or if the banks may be ahead of themselves. To answer this, we first look back at what occurred to the KRX's multiple-both absolute and

Table of Contents for the Digital Edition of ABA Banking Journal - September/October 2015

CHAIRMAN'S VIEW
UPFRONT
PICTURE THIS
ECONOMIC OUTLOOK
POISED AND PROACTIVE ON THE FARM
MEETING CUSTOMERS WHERE THEY ARE
INVESTING IN STRONG RURAL COMMUNITIES
ABA COMPLIANCE CENTER INBOX
OPERATIONS
BANKS IN INSURANCE
REAL ESTATE LENDING
BOARD MATTERS
INVESTOR PERSPECTIVE
LEGAL BRIEFS
FROM THE STATES
COMPLIANCE
INNOVATIONS IN SOCIAL RESPONSIBILITY
INDEX OF ADVERTISERS

ABA Banking Journal - September/October 2015

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