Banks / Diversified Financials

Rising Interest Rates: Not Necessarily Bad

Free Preview of Content from August 2013 Turnaround Letter

As we saw in late June, when the Federal Reserve gave a slight hint that it was beginning to think about perhaps raising interest rates, most investors have the knee-jerk reaction that rising interest rates are bad for stocks.  That is not necessarily true, either in terms of the general market or particular stocks.

Since that late-June volatility, there has been quite a bit of research published showing that the stock market often goes up during periods when interest rates are rising.  This is probably because interest rates usually rise during periods of economic strength, which is good for the market.

Many individual stocks also benefit from rising rates, particularly those in the financial services sector.  Below, we highlight six stocks from our recommend list that are likely to get direct benefits from rising interest rates.

Bank of America has struggled in recent years to rebound from the ill-timed acquisitions of Countrywide Financial and Merrill Lynch during the financial crisis.  The bank is well on the road to recovery, and a rise in rates could help it on several fronts.  The main banking business, as well as the Countrywide mortgage unit, would see lending margins increase as rates rise.  Rising rates would benefit Merrill Lynch in several ways: by allowing it to reduce or eliminate subsidies on its money market funds, allowing it to charge more on margin loans and increasing the spread that it earns on customer cash that it holds.  Management estimates that BofA could realize a $700 Million improvement in net interest income from rising rates.

Charles Schwab offers a wide variety of financial services.  Like Merrill Lynch, Schwab will benefit from the effect that higher rates will have on its money fund, margin lending and cash management lines of business. The company has estimated that a one percentage point rise in interest rates would increase net interest revenue by over 19%, and that probably doesn’t account for the benefits to the money market fund business, which is now very important to Schwab.

E*Trade Financial isn’t as diversified as Schwab, but it is arguably positioned to benefit more from rising rates as interest revenue accounts for more of its overall earnings.  In 2012, operating interest income of $1.37 billion accounted for 72% of total net revenue.  E*Trade, like Schwab, will benefit from the ability to reinvest maturing assets at higher rates as well as charge more for margin loans; and they too will be able to make more on money market accounts. 

Fifth-Third Bancorp has retreated from many of its real estate-related activities that hurt it in 2008.  Now it is focused on banking basics such as business and consumer lending.  Rising rates will increase the bank’s margins in those businesses, which have been quite thin in recent years. 

General Electric is usually thought of as a manufacturing company, but about a third of its revenues and profits come from its financial services businesses, which include business lending, inventory and receivables financing, consumer/auto loans and industrial equipment financing.  Rising rates should increase the margins in all of these activities. 

MetLife, having exited the banking business in the wake of the financial meltdown, is now a global provider of insurance, annuities and employee-benefit programs.  A key operating metric for the company is the spread between what it must pay under its insurance contracts compared with the rate of return it earns on investments.  A slowly rising interest rate environment would likely allow the company to improve that spread.

 

Rising Rates Should Help These Turnaround Letter Recommendations

Company

Symbol

Recent Price

52-Week Range

Market Cap. Bil.

Dividend Yield

Debt to Equity

Bank of America

BAC

14.52

15.03–7.10

156.0

0.28

1.30

Charles Schwab

SCHW

22.19

22.59–11.99

28.7

1.08

0.20

E*Trade Financial

ETFC

14.91

15.24–7.25

4.3

0.00

0.60

Fifth Third Bancorp

FITB

19.26

19.79–13.50

16.4

2.23

0.60

General Electric

GE

24.48

24.95–19.87

251.2

3.02

1.90

MetLife

MET

48.23

49.86–30.07

52.8

2.49

0.30

 

Other articles from the August 2013 issue

Identify & Profit from Distressed Investing

Free Report: Turnaround Investing Mistakes

Turnaround Investing Blog

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stock market advicex

 

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