After months of anticipation, the Federal Reserve, at its meeting earlier this month, raised its benchmark overnight lending rate, the federal funds rate, by 25 basis points (0.25%) . The market knew the move was coming, but what surprised were the Fed’s more hawkish outlook, indicating it expects to make rate hikes of a similar size at each of its next six meetings in 2022. Then she plans four more hikes in 2023 for a total of 11 hikes in two years.
Most banks, which tend to profit from a bit of inflation and rising interest rates as long as they don’t push the economy into a recession, had expected fewer hikes this year. While bank stock prices had certainly priced in the benefit of rate hikes to some extent, more rate hikes than expected this year also means banks have the potential to generate higher revenue and profits in 2022. Here are three bank stocks to buy.
1. Bank of America
One of the main generators of money for most banks is net interest income (NII), the profit banks earn primarily on loans and securities after covering the cost of funding those assets. Rate hikes help NII because many loan yields rise with the fed funds rate. Bank of America (BAC -0.30% ) is incredibly asset sensitive due to its large commercial loan base, which includes many variable rate loans that adjust higher with the federal funds rate, and its multi-trillion dollar deposit base.
In its 2021 annual filing, released in late February, Bank of America only expected the federal funds rate to be 1% at the end of 2022. Seven total rate hikes this year would put it around 1.75 %. Management does not provide guidance on the NII projected for the full year, but if six more hikes materialize, expect the NII – and therefore total revenue – to exceed initial projections, unless a recession that does not delay projected loan growth. Chief Financial Officer Alastair Borthwick noted on the company’s latest earnings call that the bank’s balance sheet had grown significantly in recent years and that the bank was twice as sensitive to the federal funds rate as it was. was in 2015, when the last rate cycle began.
Additionally, Bank of America has significantly improved its deposit base. Deposit costs rise with the federal funds rate, so banks that can provide low-cost, sticky deposits can increase their margins the most. Longtime banking analyst Mike Mayo of Wells Fargo pointed out in a recent research note that about half of Bank of America’s $2 trillion deposits are low-cost retail deposits from sources such as checking accounts. He doesn’t expect their rates to rise much during the first four or five rate hikes. Add to that the fact that management plans to keep spending flat this year and it’s hard not to like Bank of America under the Fed’s new plans.
Based in Dallas with nearly $97 billion in assets, Comerica Incorporated ( CMA 0.28% ) is one of the most rate-sensitive banks in the industry. According to its annual filing, a 1% increase in the federal funds rate would essentially raise the NII by 12% over the next 12 months from the end of 2021 (although keep in mind that this is not only projections and that they rarely go exactly as expected).
More than 55% of Comerica’s deposits are non-interest bearing, meaning the bank pays no interest on them. These are rate insensitive and should be much more stable in a rising rate environment. Also, Comerica has high levels of cash at the moment, on which it will earn much more yield as rates rise by leaving them to the Fed or investing in securities, which will also see their yields rise with the federal funds rate. With approximately 90% of total loans in various business segments, many Comerica loans also have floating rates that will be repriced upwards with the federal funds rate.
Considering that Comerica management had only planned four rate hikes this year, that leaves plenty of room for upside potential. The bank also has a dividend yield of almost 2.9%, even though its stock has risen almost 32% in the past six months, which is a nice added value.
3. Silvergate Capital
My final recommendation in this group is a much smaller niche bank called Silvergate Capital ( IF 3.26% ), which actually specializes in serving the crypto community. As long as it doesn’t hold Bitcoin or other cryptocurrencies on its balance sheet, the bank has created a real-time payment system that allows any party on the network to send and clear funds instantly at any time.
The payment network solves a significant problem for institutional traders looking to trade with cryptocurrency exchanges because while cryptocurrencies are constantly trading, much of the US financial system does not operate in real time. Parties using Silvergate’s payment system must open bank accounts with Silvergate which generally include large amounts of non-interest bearing deposits. In fact, Silvergate essentially gets its entire deposit base for free.
Even better for investors worried about a recession is that the bank is not really too dependent on loans. Only about 12.5% of its deposits fund loans. Approximately 54% of its total assets, or approximately $8.6 billion, are invested in fixed income securities. The bank’s overall securities portfolio in the fourth quarter of 2021 had a yield of 1.04%. Silvergate has approximately $5.4 billion more in cash. With the 10-year US Treasury yield recently at 2.16%, the bank will make a lot more money on excess cash and rolling out new securities.
Silvergate will likely need to hold more cash than normal banks due to the nature of its business. The stock also moves to some degree with the Bitcoin price and deposit flows can be influenced by crypto trading levels. But in its annual report, Silvergate estimated that a 1% increase in the federal funds rate would generate nearly 60% more NII over the next year. It’s simply stunning, but keep in mind that this is still just a projection – and investors will all be waiting to see if, in fact, the Fed is raising rates six more times this year. .
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.