This year has been challenging for investors, as persistent inflation has been the big story. With this uncertainty, the S&P 500 index got off to its worst start in 52 years.
The Federal Reserve is on a mission to bring down inflation, and one way it does so is by raising interest rates. While this could spell doom for growth stocks, other stocks stand ready to benefit.
One sector that is sensitive to changes in interest rates is the banking sector. If we are entering a period of persistent inflation and high interest rates, you'll be happy you own Bank of America (BAC -0.13%), U.S. Bancorp (USB 1.56%), and Silvergate Capital (SI 9.76%).
1. Bank of America
Bank of America ranks as the second-largest bank in the United States with over $2 trillion in assets, trailing only JPMorgan Chase.
Bank stocks traditionally make money from the interest rate spread, or the difference between the interest paid out on deposits and the interest collected on loans. Banks get squeezed when interest rates are low, causing their net interest margins and net income to fall.
This year, the Federal Reserve is aggressively raising interest rates as a means to try to bring down inflation, which increased by 8.5% from last year, according to the Consumer Price Index (CPI). Since March, the Fed has raised its federal funds rate, or the benchmark interest rates that banks lend each other money, from 0.25% to 2.5% to help bring down inflation.
Bank of America is very sensitive to changes in interest rates and has seen its net interest income grow nearly 18% through the first six months this year. The bank revealed that another 1% increase in interest rates would cause its net interest income to grow by nearly $5 billion over the next 12 months. If we are in for an era of continued higher interest rates, Bank of America would undoubtedly benefit.
2. U.S. Bancorp
U.S. Bancorp provides banking services across 2,200 branches in the Midwestern and Western regions of the U.S. and is the fifth-largest bank in the U.S., with over $530 billion in assets.
U.S. Bancorp is unique because it only focuses on traditional banking activities: making loans and growing deposits. Unlike other banks with an investment banking division to boost earnings, U.S. Bancorp concentrates only on lending to the highest-quality borrowers.
This focus on high-quality loans resulted in the bank posting a superior return on equity (ROE) compared with its banking peers. Over 10 years, U.S. Bancorp's ROE averaged 15%, beating out JPMorgan Chase's 12.5% and Wells Fargo's 12%.
BAC Return on Equity data by YCharts
U.S. Bancorp also benefits from higher interest rates. This year, the bank pulled in $6.6 billion in net interest income, up 6.6% from last year. The bank's net interest income will grow another 1.2% if the Federal Reserve increases rates by another 50 basis points -- which investors expect to happen at its September meeting.
3. Silvergate Capital
Silvergate Capital is a unique bank, serving cryptocurrency customers since 2013. The bank's earliest product was its Silvergate Exchange Network (SEN), which allowed exchanges like Coinbase or Gemini to transfer U.S. dollars between one another efficiently.
Silvergate benefits from rising interest rates more than any other bank. That's because it has over $13 billion in noninterest-bearing deposits, or 99.5% of its total deposits, allowing the bank to reap the benefits of growing interest income on its loans while not having to pay interest on almost any of its deposits.
Silvergate's net interest income grew 126% in the first half of this year to $121 million. The bank noted that a 100-basis-point increase in interest rates would cause its net interest income to grow another 15.7%.
Image source: Getty Images.
Silvergate is one of the most exciting bank stocks because of its link to the cryptocurrency markets. If the Federal Reserve were to cut interest rates down the road, it could be a good thing for risk assets like Bitcoin and Ethereum -- which could benefit Silvergate in the form of higher transaction revenue.
Silvergate is an intriguing stock that could do well in different economic environments. While its link to cryptocurrencies could make the stock more volatile, it looks like an excellent bank stock to hold for the next decade and beyond.
