The prospect of higher interest rates has been a source of great concern for many companies reliant on debt financing. The types of businesses most likely to suffer from a rise in rates include real estate investment trusts, oil and gas Master Limited Partnerships, and utilities, which carry debt-heavy balance sheets to finance their long-term assets. As rates creep higher, their costs of capital will rise -- meaning less profit to go around for shareholders.
At the same time, we can simply take the opposite view to discover which companies will benefit from rising interest rates. In particular, banks stand to gain, as they are able to increase yields on their loan portfolios faster than they have to bump up interest paid on deposits. As a result, look no further than these bank stocks to find out which companies will thrive in an environment of rising rates.
Bank on these stocks for impressive returns
Since banks traditionally borrow at short-term rates and lend at long-term rates, rising interest rates are generally seen as helpful for bank profitability. This is for a variety of reasons, including higher returns on new investments, and increased profit margins on loans. Sure the fixed income securities they hold on their books fall in value, but the actual income rolling in the door will increase.
The biggest banks in the U.S. are very much back in business, a great relief to investors who, just five years ago, weren't entirely sure the banks would survive the financial crisis. Now, those dark days seem like an eternity ago for JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC), which are reporting excellent financial results.
The improving fortunes of the nation's banks have already been seen in their underlying results over the past year. JPMorgan Chase and Wells Fargo both had great things to say in their second-quarter earnings reports. JPMorgan reported 14% higher revenue and stellar 32% growth in earnings per share. Wells Fargo, meanwhile, generated record quarterly earnings per share of $0.98, up 20% from the previous year.
JPMorgan improved its return on equity by two percentage points, to 17% from 15% the year before. In addition, management noted that net charge-offs remained near historic lows in the credit card business and are now less than half the level seen last year in the bank's real estate portfolios.
Wells Fargo, meanwhile, managed to increase its return on average assets by 14 basis points and its return on equity by 116 basis points versus the same quarter one year ago. Moreover, loan quality continues to improve, as the bank lowered its net charge-offs by $1 billion during the quarter. In the second quarter, Wells Fargo reported its lowest loan losses since the second quarter of 2006.
Don't overlook regional banks
In addition to their giant industry peers, regional banks are also performing well and may have further room to run because of their smaller sizes. Regional banks, which cater to a certain section of the country, are seeing strong results similar to their bigger banking brethren. One such regional bank worth considering is Fifth Third Bancorp (NASDAQ:FITB).
Fifth Third Bancorp is rapidly improving the quality of its balance sheet this year. Its first-quarter results showed 40% lower net charge-offs, year over year. The company's second-quarter results were equally impressive. Fifth Third Bancorp realized a 17.6% return on average common equity. Moreover, its net charge-offs declined again in the second quarter, as did its total nonperforming assets.
The winners of higher interest rates
While the market as a whole may panic at the thought of higher interest rates, bank investors shouldn't be overly concerned. A byproduct of an improving economy, of course, will be that more consumers and businesses are able to pay off their debts. This means fewer defaults, and by extension, lower loan losses for the nation's financial system. This is already reverberating through the banking system, helping these banks buffer their balance sheets and report even greater profitability.
As a result, if you're looking for stocks that can thrive within a rising-rate environment, look to the nation's banks. In particular, JPMorgan Chase, Wells Fargo, and Fifth Third Bancorp are three high-quality banks worthy of consideration.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Fifth Third Bancorp, JPMorgan Chase, and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.