When the novel coronavirus crisis hit, it seemingly challenged every industry with reduced demand, lower profit margins, or even outright shutdowns. Banks were a bit unique in that they remained open and functioning, but faced a variety of strong headwinds as a result of the coronavirus. Thus, financial stocks also took a beating during this time as well.
The resulting economic weakness from the crisis caused loan losses to rise sharply for just about every bank. In addition to that, interest rates plummeted, as they almost always do during times of crisis. Interest rates are typically lowered to help boost economic growth.
However, interest rates have risen sharply in recent months, and we see that as very beneficial for banks of all sizes.
That said, the following three big-bank stocks pay solid dividend yields, have durable competitive advantages and will benefit from rising interest rates as an added growth catalyst. These companies should benefit for different reasons, but it should all translate into earnings growth in 2021. Mega-cap banks have the ability to benefit from higher rates without the undue risk inherent in smaller companies.
My picks are:
Now, let’s dive in and take a closer look at each one.
Financial Stocks: JPMorgan Chase (JPM)
JPMorgan is a financial services conglomerate that serves a global customer base with a full suite of financial products. This includes consumer and commercial products, asset and wealth management and a host of other related services. The company can trace its roots back to 1799, and is the largest bank in the US by market capitalization by a wide margin at $459 billion. That puts JPMorgan firmly into the mega-cap stocks which are stocks with market caps above $200 billion. JPMorgan generates more than $115 billion in annual revenue.
We see mid-single digit annual earnings per share (EPS) growth for JPMorgan in the years to come, but much stronger growth than that for 2021. This is due to the sizable decline in earnings that took place as a direct result of COVID-19 in 2020 in terms of sharply higher loan losses, but also lower net interest margins. As conditions normalize, we expect JPMorgan to see materially higher earnings against 2020 results.
Like many other banks, JPMorgan suffered at the start of 2020 from much lower lending rates. Since many loan products are tied to interest rate benchmarks, such as the London Interbank Offered Rate, or LIBOR, when rates declined last year, JPMorgan’s new lending, as well as any existing loans with floating rates suffered.
This was somewhat exacerbated because deposit growth for JPMorgan was outstanding last year, with the bank’s most recent quarter posting staggering 35% growth in deposits. While that’s terrific for funding future loans, it also meant that interest expense was rising relative to interest income due to lower lending rates.
JPMorgan pulled back lending somewhat during the crisis, which makes sense given the conditions, but this combination of higher interest expense and lower lending rates was not a good one. We see these conditions unwinding in 2021 to an extent, and especially with lending rates having moved so much higher early on in 2021. For JPMorgan, this tailwind should be quite meaningful and afford the bank the opportunity to see much higher earnings this year.
Bank of America (BAC)
Bank of America, like JPMorgan, is a highly diversified financial conglomerate. The company offers a huge variety of lending and financial products, including mortgages, credit cards, auto loans, commercial banking services, wealth and investment management, and a host of others.
Bank of America traces its beginnings back to 1904, generates about $85 billion in annual revenue, and trades with a market capitalization of $309 billion, trailing only JPMorgan in the financial services industry by that metric.
Bank of America’s lending mix is similar to JPMorgan’s in that it is highly entrenched in products like mortgages and credit cards, as well as non-interest rate sensitive products like wealth management. Mortgage rates plummeted during 2020, causing a boom in refinancing activity from consumers to grab low rates while they lasted. Bank of America’s massive mortgage and related businesses stand to gain materially this year as rates have risen.
Like JPMorgan, Bank of America saw massive deposit growth in 2020 as consumers and businesses that were flush with cash stored that cash in their bank accounts in a flight to safety. That compressed margins for Bank of America, but even in the final quarter of 2020, the bank saw better lending margins, a trend which we expect to dominate in 2020 thanks to rising rates.
Overall, Bank of America’s deposit mix is favorable for a rising rate environment in that much of it pays no interest at all. And this means all of the incremental income from rising rates is kept by the bank and not paid out to customers.
Morgan Stanley (MS)
Our final stock is much closer to an investment bank than a lender, boasting a much different product and service mix than our first two stocks. Morgan Stanley is a diversified financial services firm that was born as a wealth management and trading firm, and stays true to those roots today. However, the company has a variety of ways to benefit from higher rates as well.
Morgan Stanley was founded in 1924 and while still a massive company in its own right, is nowhere near the size and scale of JPMorgan and Bank of America. The firm trades with a market capitalization of $143 billion and produces about $50 billion in annual revenue.
Morgan Stanley’s earnings actually soared in 2020 thanks to very strong trading revenue and other investment banking services and products. Morgan Stanley isn’t beholden to lending rates in the way a traditional bank is, so the credit quality problems banks ran into didn’t necessarily apply to Morgan Stanley. However, sharp movements in interest rates helped generate very strong earnings from the company’s fixed income product lines, a trend we expect to continue into 2021.
In the company’s most recent quarter, fixed income earnings soared 31% year-over-year, and while we don’t necessarily believe it to be prudent to expect this sort of gain for 2021, we do think higher rates will greatly benefit Morgan Stanley’s interest-rate sensitive lines of business.
On the date of publication, Bob Ciura did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Bob Ciura has worked at Sure Dividend since 2016. He oversees all content for Sure Dividend and its partner sites. Prior to joining Sure Dividend, Bob was an independent equity analyst. His articles have been published on major financial websites such as The Motley Fool, Seeking Alpha, Business Insider and more. Bob received a bachelor’s degree in Finance from DePaul University and an MBA with a concentration in investments from the University of Notre Dame.
