Is Compass Point's Outlook On Regional Banks Too Good To Be True?

Are regional banks in a win-win situation?

In a report published last week, Compass Point analyst Kevin Barker said that the industry was in a "Goldilocks scenario." Regional bank stocks would shoot up on an interest rate hike, according to the analyst. However, if rates stay "lower for longer," he still expects "earnings multiples to grind higher… If rates were to remain low we would expect the market to continue to search for yield and the equity risk premium will continue to decline, thereby causing earnings multiples to increase."

Regardless of whether rates went up soon are stayed near zero, the sector would be better off and is thus currently positioned "just right" for future growth.

Barker has Regions Financial Corp RF, Zion Bancorporation ZION, Synovus Financial Corp. SNV and Citizens Financial Group Inc CFG rated as Buy.

Not So Fast

But Tim Melvin, a Marketfy maven and banking sector expert, disagrees with Barker. He said that a rate increase will be key in catalyzing both stock prices and earnings: "Net interest margins need to go up."

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According to Melvin, regional banks won't be able to stay in their current "sweet spot" if the Fed doesn't decide to tighten policy. As of now, he believes that "everything is going right" for the industry "except net interest margins."

Melvin said a three- to five-year stretch of incremental hikes would lead to a steady period of growth for mid-large cap lenders.

But in the short term, he thinks that the real path to growth for regional banks will be acquisition. While interest rates stay low—even after the first few hikes, Melvin says rates will still be minuscule in absolute terms and thus meaningless in the short run—he doesn't expect earnings to be able to expand significantly. Therefore, he favors banks that have a track record of making creative, successful acquisitions: Huntington Bancshares Incorporated HBAN, Fifth Third Bancorp FITB and Bank of the Ozarks Inc OZRK. On the other hand, banks that make poor buys or make none at all will fall behind, according to Melvin.

This forecast also encourages optimism from Melvin on smaller community banks, since those will be the ones that the larger regional banks will move to buy out.