Morgan Stanley likes these Banks (ZION) (JPM) (AMTD)

What's Hurting Small Bank Stocks? Small bank stocks have suffered recently. Here's the reason: Morgan Stanley analyst Ken Zerbe says that bank profits are going to get squeezed, if the Fed's quantitative easing goes into effect. He was on Bloomberg's Taking Stock, podcast on Wednesday. The problem is the interest rate spread will go down, says Zerbe. The interest spread is the difference between what the banks pay for money, and the profits they make on loans. Zerbe expects the rate on 10 year treasuries to decline from around 2.24% presently, to 2%. When rates go down the spread also declines. In addition, that will trigger a lot of ‘loan pre-payments,' which will also hurt banks. When corporations pay off their loans ahead of time, bank profits suffer. "The real question is how long the 10 year stays at 2%," says Zerbe. The good news for bank stocks is that Ken Zerbe and Morgan Stanley expect inflation to trigger a 4% rate, with a bigger spread, by the end of 2011. The movement in rates from a low 2% to 4% will be a J curve. One of the banks that will get hurt at first, but then will benefit later is Hudson City. HCBK Zerbe thinks Hudson City is a solid bank. If his theory is correct, you should wait to purchase Hudson City. Zerbe is currently recommending Zions Bank, ZION, JP Morgan Chase JPM, and TD Ameritrade AMTD. Improving credit quality, and finalization of the new Basil 3 agreement will benefit them. Apparently, Zerbe thinks these large banks are more diversified than smaller banks like Hudson City who make most of their profits from loans and mortgages.