Are Bank Stocks Always the Best Choice During Interest Rate Hikes?

"Focus on Dividend Capacity Rather Than Interest Margin"

[Asia Economy Reporter Minji Lee] As concerns about inflation originating from the U.S. have raised expectations that the Federal Reserve's tapering (asset purchase reduction) will accelerate, investors are flocking to bank stocks. However, securities experts advise that since the operating environment of banks has changed, investors should approach with dividends in mind rather than solely seeking benefits from rising interest rates.

According to the Korea Exchange on the 14th, the KRX Bank Index rose 5.05% from 759.75 to 798.13 through the previous day this month, significantly outperforming the KOSPI return (-0.82%). While inflation concerns have expanded over the past two weeks, deepening the KOSPI's decline (-2.35%), the KRX Bank Index increased by 1.3%. By stock, JB Financial Group (5%), Industrial Bank of Korea (4.9%), and Jeju Bank (3%) showed the highest gains.

The saying "financial stocks dominate during interest rate hikes" proved accurate. The outstanding performance of bank stocks during periods of rising interest rates is due to improved profitability from increased net interest margins, which acts as a factor driving stock price increases. In March, when the U.S. 10-year Treasury yield surged sharply and expectations grew that the Fed might accelerate rate hikes, the KOSPI rose about 1.3% over the month, while the KRX Bank Index surged 15.7%.

However, there is analysis suggesting it is problematic to approach bank stocks solely as beneficiaries of rising interest rates. Banks have adjusted to minimize the 'duration gap' between assets and liabilities, so they are expected to be less affected by interest rate changes. The duration gap is a sensitivity indicator showing how much the value of assets and liabilities differ when market interest rates fluctuate. During periods of rising interest rates, if the duration gap between assets and liabilities is positive, the increase is first reflected in assets with shorter duration, causing net assets to rise; if negative, the opposite occurs. Youngsoo Seo, a researcher at Kiwoom Securities, said, "An increase in the base interest rate without improvement in borrowers' repayment ability can lead to deterioration in banks' soundness, so the positive impact of base rate hikes on the profitability of the banking sector will be limited."

In the securities industry, it is advised to focus on dividend capacity driven by improved performance of non-bank subsidiaries rather than expectations of rising interest margins. In the first quarter, the net income of the three major financial holding companies?Shinhan Financial Group, KB Financial Group, and Hana Financial Group?increased by 28%, 74%, and 26% respectively compared to a year ago, with the non-bank sectors such as securities and credit cards contributing 86% of the profits. Due to the profit improvement in the non-bank sector, the dividend yield this year is expected to rise to 7.5%, higher than last year's 4.9%. It is also predicted to show a dividend yield in the 7% range in 2022.

Researcher Jaewoo Kim of Samsung Securities explained, "The improvement in earnings in both the banking and non-banking sectors is happening across the industry," adding, "Since first-half profits are expected to reach 70% of last year's annual profits, there is a significant possibility that the dividend payout ratio will normalize this year."