These 7 financial firms are making money as interest rates soar

It’s been a wild year for the stock market. With inflation at its highest level in 40 years, the Federal Reserve is aggressively raising interest rates to bring it down. The actions have rippled through every market, from bonds to stocks to cryptocurrencies β€” all of which have declined this year.

While higher interest rates raise borrowing costs, there is one area of ​​the economy that welcomes them: the financial sector. This is because many companies in the industry benefit by charging customers higher interest rates on their loans.big banks like Bank of America (BAC 0.86%) and JPMorgan (JPMorgan 1.19%) As a result of these higher rates, interest income has increased. Here’s what rising interest rates mean for the economy and seven financial firms that make money.

Here’s why interest rates are rising

The Federal Reserve plays a key role in the economy, influencing monetary policy primarily by adjusting interest rates. It sets the overnight lending rate between banks — called the federal funds rate. Changes in interest rates on this loan have knock-on effects on all interest rate products, including mortgage rates, U.S. Treasuries and municipal bonds.

When the economy slows, as in 2020, the Fed can lower interest rates to stimulate the economy, encourage more spending and support asset prices. Low interest rates encourage borrowing as consumers refinance home loans or businesses restructure debt to take advantage.

When the economy is overheating and inflationary pressures rise, the Fed raises interest rates to try to cool it down. Since March, the Fed has raised its effective federal funds rate from near zero to more than 3%, the fastest rate hike since 1980.

Effective Fed Funds Rate data from YCharts

What rising interest rates mean for consumers and banks

Rising interest rates hit consumers who now face higher borrowing costs. The rate on a 30-year fixed-rate mortgage hit 7.16% at the end of the month, the highest rate since 2001, according to the Mortgage Bankers Association. Higher interest rates have put pressure on housing affordability for many potential homebuyers.

For saving consumers, higher interest rates mean you can earn more with a high-yield savings account or certificate of deposit that you buy today. E.g, Ally Finance It recently raised its savings account rate to 2.25%.

Banks welcome higher interest rates. That’s because banks have traditionally made money through the spread, or the difference between the interest they earn on the loan and the interest they pay on the deposit.

When interest rates are lower, the spread between interest earned and interest paid narrows and reduces the amount the bank earns based on the spread. When interest rates rise, this spread increases, allowing banks to earn more interest income.

Seven financial institutions benefiting from rate hikes

Banks made money from net interest income (NII) this year. In the third quarter, many banks saw impressive year-over-year NII growth. Here they come:

The bar chart shows the quarterly change in net interest income for seven financial institutions.

Data source: company documents. Author chart.

Several of these banks have benefited greatly from higher interest rates because they have large amounts of interest-free deposits. These are deposits that banks don’t pay interest on – providing them with a cheap source of funding that is not affected by rising interest rates.

Silvergate Capital (SI 2.88%) is a bank that serves cryptocurrency customers.Its well-known product is the Silvergate Exchange Network, a payment network that helps crypto customers easily transfer dollars between exchanges, such as Coinbase and bit stamp. Since 99% of deposits at Silvergate are interest-free, there is no need to add interest on deposits to benefit from rising interest rates. The bank’s net interest income rose 132% this year.

Bank of America, JPMorgan, PNC Finance (PNC 1.16%)and Huntington Bank shares (HBAN 1.41%) They also have relatively more interest-free deposits, ranging from 29% to 37% of total deposits.

Financial Services Company Charles Schwab (SCHW 3.70%) In recent quarters, it has positioned itself at higher interest rates by increasing its cash holdings and shortening the investment horizon so it can take advantage and invest at higher interest rates.

at last, Commonwealth of Washington (WAFD 2.58%) It surprised investors when it pushed earnings down on Oct. 13. Helping the bank has been a shift in recent years towards commercial lending and transactional deposits. Its business loans have floating rates and short-term maturities, ideal for banks to take advantage of these rate hikes. Transaction deposits are similar to deposits in checking accounts, reducing their sensitivity to the impact of interest rates on their interest payments.

Banks benefit from higher rates, but reason to be cautious

When interest rates rise, banks can be solid investments because they can earn more interest income. However, investors have reasons to be cautious. In the short term, higher interest rates could dampen lending as consumers and businesses tighten their belts and demand for loans falls. This is what happens in the real estate market.

Mortgage demand is at its lowest level since 1997, according to the Mortgage Bankers Association. Not only that, but companies with lower credit ratings are finding it difficult to find lenders. Fewer loans means lower profits for banks, which could offset any gains they make from net interest income.

Banks could face some headwinds from a slowdown in lending in the coming quarters. However, higher interest rates for an extended period could be a good thing for banks. That’s because they can earn more interest income than they have in the past 15 years. If so, bank stocks could be an important part of your balanced portfolio.

Bank of America is an advertising partner for The Ascent, a Motley Fool company. Charles Schwab is an advertising partner for The Ascent, a Motley Fool company. JPMorgan is an advertising partner for The Ascent, a Motley Fool company. Courtney Carlson has no positions in any of the stocks mentioned. The Motley Fool has and recommended positions at Coinbase Global, Inc., JPMorgan Chase and PNC Financial Services. The Motley Fool recommends Charles Schwab and Silvergate Capital Corporation. The Motley Fool has a disclosure policy.

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