In February, the consumer price index (CPI), a measure of inflation, rose 7.9%, the fastest rise in more than 40 years.
Now, after fighting the economic damage from the pandemic, the Federal Reserve is shifting its attention to inflation. On March 16, the Fed raised interest rates by 25 basis points, its first interest rate increase since 2018.
Jerome Powell, Fed chairman, recently expressed concern that "inflation is much too high" and that his group "will take necessary steps to ensure a return to price stability."
Image source: Getty Images.
Fed officials suggested that the central bank may make six increases of 25 basis points each this year, which would bring the federal funds rate from its historically low levels to about 1.75%, or 175 basis points by year-end.
With the Fed aggressively raising interest rates, some industries will come out ahead. One sector that stands to benefit is the financial sector, with companies like Silvergate Capital (SI 3.23%), Bank of America (BAC -1.01%), and Charles Schwab (SCHW -0.66%) ready to take advantage.
1. Silvergate Capital
Silvergate Capital is a unique bank that focuses on providing products and services to those in the cryptocurrency market. The bank began focusing on crypto customers in 2013 when the financial infrastructure for Bitcoin and other digital currencies was relatively undeveloped.
The bank's main product is the Silvergate Exchange Network (SEN), a payment network that lets customers transfer dollars between exchanges like Coinbase, Gemini, and Bitstamp. This product has helped Silvergate to grow its noninterest-bearing deposits in recent years -- which have become a primary source of funding for the bank.
Silvergate has $14.2 billion in deposits that do not pay interest, or 99.5% of its total deposits. Because these accounts aren't accumulating interest expense, Silvergate can benefit in a big way when interest rates continue to rise. It can collect higher interest income from its investments but won't have to pay out interest on these accounts.
According to Silvergate's recent filing, a 100-basis-point increase in interest rates would increase its net interest income by 60%. If the Fed continues to be aggressive through the end of the year, a 200-basis-point change will raise net interest income by an eye-opening 124%.
2. Bank of America
Bank of America is another player that will benefit from rising interest rates. Like Silvergate, it gains when interest rates rise because it can earn more on new loans than it has to pay on deposits. It is also well positioned because it has a large number of commercial loans with floating rates, which means when the federal funds rate rises, so will the interest earned on these assets.
Image source: Getty Images.
One aspect of rising interest rates that investors must consider is their impact on the broader economy. Because the Fed is looking to cool down spending to control inflation, it could lead to slower growth in the economy. For example, if rates rise too quickly and hurt consumer confidence, mortgage originations could decrease, hurting lenders like Bank of America.
However, banks are ready to exit the era of ultra-low interest rates, which have kept margins compressed. Alastair Borthwick, Bank of America's chief financial officer, has said the bank expects robust growth in net interest income in 2022. According to a recent filing, a rise in interest rates of 100 basis points would increase Bank of America's net interest income by $6.5 billion over the next 12 months.
3. Charles Schwab
Charles Schwab is another in the financial industry that welcomes higher interest rates with open arms. The company provides banking services, wealth management, asset management, and financial advisory services.
Schwab, like others in its sector, has suffered from the low interest rate environment. Lower rates have compressed its net interest margin (NIM), a measure of how much interest income a firm brings in versus how much it pays out on deposits. In 2019, Charles Schwab's NIM was 2.41%, but it fell to 1.45% in 2021 as a result of the near-zero interest rates.
Lower interest rates hurt its net interest revenue and bank deposit fee revenue. The company is also hurt on the asset management side, as it has waived fees to ensure positive returns for clients on money market funds. Despite the lower interest rates, Schwab's net interest revenue rose 31% to $8 billion in 2021.
Rising interest rates would positively impact Charles Schwab's net interest revenue as yields on interest-earning assets rise faster than the cost of funding. According to the firm, a 100-basis-point increase in interest rates would raise its net interest revenue by 14.1%.
