Last week, the Federal Reserve continued its fight against inflation, raising its benchmark interest rates by 75 basis points. Since March, the central bank has raised interest rates from near-zero to 3.25%.
The aggressive rate hikes over the past six months created ripple effects across the stock market and the broader economy. For instance, the financial sector as a whole feels the impact of raised interest rates. This sector is one of CEO Warren Buffett's favorites to invest in, with Berkshire Hathaway's (BRK.A -0.30%) (BRK.B -0.26%) portfolio holding stock in various banks, rating agencies, and payment processors. Here's how rising interest rates affect three of Warren Buffett's top stocks.
Image source: The Motley Fool.
1. Bank of America
Bank of America (BAC -1.07%) has over $2 trillion in assets and is the second-largest bank in the U.S., behind JPMorgan Chase (as measured by assets under management).
Bank of America, Buffett's second-largest holding, is also one of the most interest rate-sensitive banks you can find. It's particularly sensitive to changes in interest rates because 40% of its $1.4 trillion in deposits from consumer wealth management clients are in low- or no-interest checking accounts. In a rising interest rate environment, that's a good thing because the bank can rake in higher interest income on loans, while the interest paid on deposits doesn't increase by as much.
In the first half of this year, Bank of America's net interest income (NII) increased by 18% year over year to $24 billion. In its recent filing for June 30, the bank said a 100-basis point increase in interest rates would cause NII to increase by $5 billion over the next 12 months. Since that regulatory filing, the Federal Reserve has raised rates by 2.25%.
Raising rates benefit the bank's net interest margin. However, if rates rise too quickly and negatively affect the economy, the bank could be forced to increase its provision for credit losses while also seeing loan growth slow down.
2. Moody's
Moody's (MCO -1.58%) provides credit ratings for companies worldwide and is an essential part of the fixed-income market. The company dominates the credit rating business alongside S&P Global, controlling a roughly 40% market share each.
Over the last decade, Moody's benefited from ultra-low interest rates, encouraging companies to issue debt constantly. This year, companies issued bonds at a much slower pace.
According to the Securities Industry and Financial Markets Association (SIFMA), U.S. corporate bond issuance is down over 23% from last year and totals about $1 trillion. As a result, Moody's revenue from this source was down 24% compared with last year.
If rates continue rising, Moody's rating business could continue having a hard time. The company will need to lean on its analytics segment, where it helps companies navigate uncertain credit markets, supply chain issues, and a transition to cleaner energy. The analytics segment revenue was up 20% this year, helping Moody's stay resilient amid rising rates.
3. U.S. Bancorp
U.S. Bancorp (USB -1.49%) provides banking services and has $530 billion in assets, making it the fifth-largest bank in the U.S.
The bank focuses purely on traditional banking activities: making loans and taking in deposits. The bank is very selective about its loans, focusing on the highest-quality borrowers it can find. For this reason, the bank produces a strong return on equity that has outpaced its banking peers over the last decade.
Its focus on traditional banking makes it sensitive to interest rates, and this year the bank's NII has grown by 6.6%. In its June 30 filing, the bank said a 200-basis point increase in interest rates would cause net interest income to increase another 1.54%. Like Bank of America, if rising rates negatively impact the economy, U.S. Bancorp could see a slowdown in loan growth.
