Banks aren't necessarily the most exciting companies to invest in (and that's partly by design). But they can be pretty good investments for times like those we are in now.
Analysts at Bank of America and Goldman Sachs are projecting as many as seven interest rate increases this year as the Federal Reserve does its part to combat rising inflation. Rising interest rates generally bode well for banks. That's because banks make money from the interest rate spread, or the difference between interest earned and interest paid out.
In this economic environment, some stellar banks with a niche focus can make great investments. Three banks that are laser-focused on their niche that would also benefit from rising interest rates are SVB Financial Group (SIVB.Q 2.00%), Silvergate Capital (SI -2.44%), and Live Oak Bancshares (LOB 0.08%). Let's find out a bit more about these three top bank stocks.
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1. SVB Financial Group: The bank of Silicon Valley
SVB Financial Group is a bank for entrepreneurs and start-ups. The company provides funding to start-ups in areas like technology, life sciences, healthcare, private equity, and venture capital.
This focus on start-ups has paid off well for SVB Financial. Since 2007, the bank has grown its interest-earning assets from just $5 billion then to $158 billion in 2021. That's a 28% compound annual growth rate over 14 years. Its net interest income has grown from $400 million to $3.2 billion during this same period -- an impressive 16% growth compounded annually. This translated into outstanding stock performance, with SVB Financial crushing the S&P 500, returning 960% versus 304% since then.
SIVB Total Return Level data by YCharts
In 2021, SVB put up a net interest income of $3.2 billion, up 48% from the previous year. It benefited from robust private equity (PE) markets and venture capital (VC) activity. VC and PE reached record levels last year, with VCs in the U.S. making $330 billion in investments and $774 billion in exits, while U.S. PE deal value totaled $1.2 trillion.
While the bank is optimistic about 2022 growth, management keeps a close eye on changes in valuations or liquidity in the marketplace that could cause a pullback in venture capital or private equity activity. While it is on guard for smaller gains from its investments, the bank believes increased interest rates will offset the impact.
For every 25-basis point increase to short-term interest rates, SVB Financial estimates it would make $100 million to $130 million in pre-tax net interest income. Meanwhile, client investment fees would increase $205 million to $235 million with the first 25 basis point increase and $20 million to $50 million with each subsequent 25-basis point increase.
SVB Financial Group is a well-run bank that has outperformed for over a decade, and the business should continue to outperform in this current market environment.
2. Silvergate Capital: The bank specializing in cryptocurrency
Silvergate Capital was one of the first banks to serve cryptocurrency customers in 2013. The bank saw an opportunity with an obscure regulatory environment and jumped in.
Silvergate has a range of customers, including 94 digital currency exchanges, 894 institutional investors, and 393 other customers working on applications, cryptocurrency mining operations, and other services. Its primary product is the Silvergate Exchange Network (SEN). This payment network helps customers transfer U.S. dollars between different exchanges like Coinbase, Gemini, and Bitstamp. Over the past three years, Silvergate has grown its transaction revenue at 162% compounded annually.
It doesn't just have the exchange, though. It also offers digital asset custody and collateralized lending through its SEN Leverage product. These products have propelled strong deposit growth for Silvergate, growing 705% over the past five years to $14.3 billion.
Even better, 99.5% of these deposits are in the form of noninterest-bearing deposits, so Silvergate stands to benefit from rising interest rates. That's because it could continue to invest deposits into loans at higher interest rates, but it won't face higher interest rate expenses because these accounts are non-interest bearing. A 100-basis point change in interest rates would increase Silvergate's net interest income by nearly 60% -- making it another stellar bank to own for rising rates.
Image source: Getty Images.
3. Live Oak Bancshares: The bank serving small businesses
Live Oak Bancshares is a regional bank that focuses on serving small business customers. The bank has been one of the largest Small Business Administration lenders over the past few years. In 2021, Live Oak Bank ranked No. 1 in the SBA 7(a) lending program, lending $307 million across 223 loans. Newtek Small Business Finance and The Huntington National Bank were second and third, extending $218 million and $138 million in loans to small businesses.
Live Oak Bank has invested in technology to improve its banking platform for small businesses. One way it is doing this is through a fintech solution called Finxact. Finxact's core modernizes Live Oak's platform for processing bank deposits and making loans, allowing it to roll out new digital banking products quickly.
Huntley Garriott, president of Live Oak Bank, said this technology would extend its banking-as-a-service (BaaS) platform. BaaS is a huge opportunity in banking. That's because this service opens up a bank's services to third-party developers, who can use this to create more financial apps for consumers.
According to Allied Market Research, the global BaaS market was valued at $2.4 billion in 2020 and is projected to grow 17% to $11.3 billion by 2030. Not only that, but BaaS can drastically reduce the cost of adding deposits. According to researchers at Oliver Wyman, a subsidiary of Marsh & McLennan, the cost of acquiring a new customer can range from $100 to $200. However, with BaaS technology, that cost can range from $5 to $35.
Live Oak Bank would also benefit from rising interest rates. According to its recent filing, the bank expected net interest income to increase 1.2% for a 100-basis point increase in interest rates. Given its investments in technology and a laser focus on serving small businesses, Live Oak Bank is another strong business to own in this market.
