Interest Rates Rise – Who Benefits?

The Federal Reserve finally decided to raise the base interest rate by 25 bps. The first thing to happen after the announcement was that banks raised their lending rates.

Within the banking universe, the banks that have the highest probability of utilizing higher interest rates to increase shareholder value are the small community banks. These banks are generally straightforward lending institutions that borrow short (deposits), and lend long (mortgages). They do not share the risks or financial complexity of the larger banks.

Ocean Shore Holding Company (Nasdaq: OSHC) is a good example. This is a community bank on the New Jersey shore that completed a second step mutual conversion about 5 years ago. They borrow short and lend long, all in the local community that they understand very well. They simply grow their deposit base and local loan book. In the low rate environment that has been in place for the last 5 years, they have delivered a total annualized return to shareholders of 13.3%. They are currently selling for 98% of book value.

The SEC requires all companies to publish a section in their 10K's and 10Q's called "Quantitative and Qualitative Disclosures about Market Risk". In this section the company assesses the impact of the most significant market forces that in their judgment affect the financial results of their company. For banks this should include the potential changes in interest rates. This is a good starting place to understand the impact of rising rates on OSHC. The relevant section from the 10Q for 3rd quarter for OSHC is shown below:

MARKET RISK MANAGEMENT

Net Interest Income Simulation Analysis

We analyze our interest rate sensitivity position to manage the risk associated with interest rate movements through the use of interest income simulation. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest sensitive." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period.

Simulation analysis is only an estimate of our interest rate risk exposure at a particular point in time. We continually review the potential effect changes in interest rates could have on the repayment of rate sensitive assets and funding requirements of rate sensitive liabilities.

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