Over the past year, inflation has remained stubbornly high, wreaking havoc for consumers and investors alike. Economists hoped August would bring better news, but it didn't.
Earlier this week, the U.S. Bureau of Labor Statistics released its August data for the consumer price index, which measures the changes in the costs of consumer goods. The release showed that prices were up 8.3% on an annual basis, with higher food and housing costs offsetting lower energy prices.
Now investors look to the Federal Reserve, which has been aggressively fighting inflation with its primary tool: interest rate increases. When the Fed raised rates by 75 basis points in June, it was its largest rate hike in 28 years. The Fed raised rates another 75 basis points in July, and investors expect a similar increase during its meeting next week. While rising rates hurt most companies by raising the cost of borrowing, bank stocks benefit. Here's why.
One of the main ways banks make money is by charging customers higher interest rates on credit than they pay customers on deposits. While some banks generate extra income from fees and others have highly profitable investment banking divisions, most banks generate earnings from interest rates.
Banks face challenging times when interest rates are low because that tends to compress interest rate spreads, or the amount of interest charged minus the amount paid out. When interest rates rise, this spread tends to widen, and banks see their profitability improve. With that said, here are three banks that stand to benefit in a big way from continuing rate increases.
1. Bank of America
Bank of America (BAC -1.61%) ranks as the second-largest bank in the U.S. with over $2 trillion in assets and is one of the most interest-rate-sensitive major banks out there. One reason is that 40% of its $1.4 trillion in deposits from consumer wealth management clients is in low- or no-interest checking accounts. As a result, Bank of America can earn more on these deposits as rates rise.
Through the first six months of the year, Bank of America's net interest income (NII) rose by 18%, to $24 billion, versus the first half of the previous year. In its recent regulatory filing, the bank said a 100-basis-point increase in interest rates would help NII grow by $5 billion over the next year, an 11% increase from its trailing-12-month NII.
2. The Bancorp
The bank handles back-end services like regulatory compliance and access to payment networks, like Visa and Mastercard. Over 100 clients, like PayPal Holdings and Chime, turn to The Bancorp for these services to help nonbank clients offer their own payment products.
The bank's net interest income didn't change much in the first half of the year, but that's due to a timing difference in how interest rates affect its deposits and loans. Most of The Bancorp's deposits are through prepaid and debit card account deposits, and when interest rates go up The Bancorp quickly adjusts the interest rates it pays on these deposits.
However, its loans are variable rates, repriced on a lag, and take longer to adjust to changes in interest rates. These loans are generally repriced monthly or quarterly, and the bank sees higher interest rates serving as a tailwind in the second half of this year.
According to its regulatory filing, a 100-basis-point parallel increase to interest rates would help NII increase by 9%, while a 200-basis-point increase would help NII grow by nearly 19%.
3. Silvergate Capital
Silvergate Capital (SI -21.05%) provides banking services to cryptocurrency customers, which it has done since 2013. One of its earliest products was the Silvergate Exchange Network (SEN), a payment transfer network that allows crypto exchanges, like Coinbase Global or Gemini, to transfer U.S. dollars efficiently. The SEN is interesting because it gives Silvergate a vast amount of non-interest-bearing deposits, which allows the bank to benefit significantly when interest rates go higher.
The bank has over $13 billion in non-interest-bearing deposits, or 99.5% of its total deposit base. As a result, Silvergate reaps the benefits of higher interest rates on its loan portfolio while it doesn't have to increase what it pays out on its deposit accounts.
Silvergate's NII grew 126% to $121 million in the year's first half. In its recent regulatory filing, the bank noted that a 100-basis-point parallel shift up in interest rates would cause NII to increase by nearly 16%, while a 200-basis-point increase would cause NII to grow by 31%.