When the Federal Reserve Board met last week, they voted unanimously to raise the Fed Funds target rate 25 basis points to a range of 1.75-2%, the 7th hike since the central bank began lifting short-term rates in December of 2015. Chairman Jay Powell indicated that there would be at least one more rate hike in 2018 and probably two. The Fed Funds futures contract at the Chicago Mercantile exchange show that traders are currently assigning a 93% chance of at least one more hike and a 53% chance that the Fed will raise rates twice more in 2018.
Rates had been near zero (with a target range of 0 -0.25%) since the financial crisis in 2008 when the Fed felt the need to stimulate the economy quickly with historically low short-term rates combined with quantitative easing - purchasing debt securities of longer maturities - that held the long end of the rate curve low.
Now with unemployment at historic lows, GDP growth near 3% and inflation right at the Fed's target of 2%, the central bank is slowly and deliberately inching rates back up to avoid an overheating economy.
One beneficiary of higher interest rates is the consumer lending sector, which can issue new loans at higher rates and sees increased revenue on existing floating rate debt.
Santander Consumer USA Holdings (SC) is a U.S. subsidiary of Banco Santander, the world's 9th largest financial institution. Focused on automobile finance, SC makes new vehicle loans, new vehicle leases and offers financing for dealer inventories.
The average interest rate on a new car loans was around 8% in 2006 before falling to 3.9% in December of 2012. The average had risen to 5.7% by March 2018, then most recent month of data available from automobile site Edmunds.com. The average price of a new car is now $34,623 and the average length of an auto loan is now 69.5 months, both all-time highs.
It's easy to see that more expensive vehicles, higher interest rates and longer terms all spell bigger profits for the lender.
SA turned in a big earnings beat in the first quarter, posting earnings of $0.67/share, 67% higher than the Zacks Consensus Estimate of $0.40. Estimates for full year 2018 are on the rise and, after 7 recent upward revisions, now stands at $2.30/share - up sharply from $1.90/share 60 days ago. Santander Consumer is a Zacks Rank #1 (Strong Buy).
Encore Capital Group (ECPG) provides borrowers and homeowners innovative solutions across a broad range of assets. In a sector once known as "debt-consolidators", Encore makes use of sophisticated analytics to offer distressed borrowers solutions to their debt issues with affordable monthly payments, while maintaining an attractive risk profile.
Rising rates on revolving debt spells more customers for Encore Capital.
Encore's revenues are growing at 10-13% over 2017, and with many costs largely fixed, net earnings are growing even faster. The Zacks Consensus Estimate for 2018 is now $4.81/share, a 20% increase over 2017. Encore is a Zacks Rank #1 (Strong Buy).
The Pawn King
Often overlooked in the world of consumer finance, pawn stores allow credit-constrained customers valuable access to needed cash, while providing the operators with an opportunity to make securely collateralized loans ant attractive interest rates.
With over 2,200 locations in the U.S., Mexico, Guatemala, El Salvador and Columbia, First Cash (FCFS) is a leading operator of retail stores that offer short term loans as well as the sales of pre-owned jewelry, consumer electronics, power tools and musical instruments.
Approximately 75% of First Cash customers who take a loan secured with a personal asset pay back the loan in full and recover their collateral. The average service fee for these loans is 12-13% per month.
The other 25% (who do not repay the loan) forfeit their collateral which is then sold in the retail stores at an average margin of 35-40%. The scale of First Cash's operation means they can sell items in multiple markets and maximize both the rate of merchandise turnover and the price received.
In its most recent announcement, First Cash reported net earnings of $0.90/share - beating consensus estimates of $0.75/share, announced the opening and acquisition of 156 additional stores, raised full year guidance and announced a $100M share repurchase program.
The Zacks Consensus Earnings Estimate for 2018 has risen to $3.54/share, a 30% increase over 2017. First Cash is a Zacks Rank #1 (Strong Buy).
Learn to Profit from Rising Rates
Rising interest rates are often seen as a constraint on corporate earning and share prices, but if you know where to look, you can find companies that perform best in a rate-hike environment. With the Fed promising increased transparency and telegraphing that more increases are on the way, investors can profit by owning these consumer finance firms.
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Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free reportSantander Consumer USA Holdings Inc. (SC): Free Stock Analysis ReportFirst Cash, Inc. (FCFS): Free Stock Analysis ReportEncore Capital Group Inc (ECPG): Free Stock Analysis ReportTo read this article on Zacks.com click here.