With the Fed signaling further rate hikes ahead, bank investors may want to know which investment strategies have worked best in a rising rate environment historically. This paper leverages our empirical work on the SNL bank fundamental data to aid investors in selecting bank stocks as rates rise.
Main Findings of This Study
In a rising rate environment, fundamental-only (income statement/balance sheet) strategies are less effective and investors should focus on valuation. This report highlights three key valuation metrics, two of which are not widely used, but highly effective: pre-provision net revenue to price and core EPS to price.
Investors should also focus on deposit structure as rates rise, specifically a bank’s level of “interest free” deposits relative to total deposits.
A four-factor model built from these metrics had long-only annualized excess returns of 11.1% during periods of rising short-term rates, with a hit rate of 75%.
Fifth Third, Regions Financial, JPMorgan Chase, and Citigroup top the list of best ranked Russell 3000 banks (market cap greater than $1 billion) based on the most effective rising rate strategies historically.