Higher Interest Rates Are Great for This Stock
When the Federal Reserve Board meets on March 16-17, many expect its members to approve the first in a series of interest rate hikes to help get inflation back under control. It would be the first interest rate hike since before the start of the coronavirus pandemic roughly two years ago when the Fed lowered the federal funds rate to the 0.00%-0.25% range.
This is not exactly welcome news for many companies, since it means the cost of borrowing will go up, but there are some companies that will be appreciative. Banks, for instance, prefer higher interest rates because they are the ones doing much of the lending, and higher interest rates allow them to profit from the spread between the interest they pay out to creditors and account holders and the interest they receive on loans. One bank, in particular, that is poised to benefit from higher interest rates is Capital One Financial (NYSE: COF).
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Credit card income jumps in Q4
Capital One is the 10th largest bank in the U.S., with about $381 billion in assets under management as of Dec. 31. But it's better known as a credit card company because it is one of the leading issuers of credit cards in the country.
Capital One made about 63% of its $8.1 billion in fourth-quarter revenue from its credit card segment, with 28% coming from its traditional consumer banking business and the rest, about 9%, from commercial banking. Overall, revenue was up 4% year over year in the fourth quarter.
Loans increased 6% year over year in the fourth quarter to $115 billion, with credit card loans jumping the most (9%). Credit card revenue climbed 15% year over year to $5.1 billion.
Net interest income (NII) -- the amount of income gained from interest minus the expense paid out on the interest-bearing products -- was up 8% in the quarter year over year to $6.1 billion, and 106% in all of 2021 to $26.1 billion.
The net interest margin -- the difference between the interest received and the interest paid out -- rose to 6.6%, up from 6% a year ago. That is about twice the margin of the average bank. It's higher because Capital One gets most of its income from credit cards, which carry higher interest rates.
That margin should grow even wider this year as Capital One heads into a period where we should see an extended period of steady interest rate hikes, including an estimated four to seven this year.
Interest rate hikes will boost net interest income
Capital One's stock price is down about 8% in 2022 through March 9, but most of the decline has come within the past couple of weeks, coinciding with Russia's invasion of Ukraine. Last year, the stock price was up 49%. And this year, the consensus price target over the next 12 months is $185 a share, which would be about a 40% gain from its current price.
The reason has a lot to do with rising interest rates, as chief financial officer Andrew Young said on the fourth-quarter earnings call. "As rates move up, [it] will clearly be a tailwind to NII," Young said. A 50-basis-point increase in interest rates over the next year would translate to a 1.9% bump in net interest income, or about $500 million, Young said.
Also, economic growth, low unemployment, and a winding down of COVID-19 mandates should lead to increased consumer spending, which means higher credit card balances. That, in turn, would expand the net interest margin. It would also keep the net charge-off and delinquency rates low. Currently, Capital One has a charge-off rate (bad debt written off as a loss) of 0.79%, which is very low, and a 30-day delinquency rate of 2.25%, down from 2.41% in the fourth quarter of 2020.
Projections could change if inflation doesn't come down as expected. And an extended conflict in Ukraine could change all expectations.
There are a lot of uncertainties right now, but one thing that is almost certain is that the Fed will be raising interest rates, and that will be good for Capital One.
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Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
