Morningstar - Q4 2022 - 67

consumption went extremely low, and there's
only so many goods you can buy. Some people had
income replacement from unemployment
that was higher than their regular wages were.
There was a moratorium on paying interest on
student loans and on mortgage payments
in some cases. People were able to build up their
savings, and because they were saving a lot
of money, they were not defaulting on their loans.
As a result, credit costs at the banks went far
below normal, even lower than during economic
expansion periods.
Higher interest rates are going to help the
net interest income of banks, but there
will be a somewhat countervailing effect as credit
costs increase. That said, it's not going to
be really bad. We're going from abnormally low
to something a little bit more normal, which
is higher than what it has been over the previous
couple years. Most people are not forecasting
that we're going to get into a severe recession
with high unemployment rates and relatedly high
credit costs.
I would note that if you're looking for companies
that will benefit from rising interest rates, you
should look for companies with low deposit betas.
You're also looking for companies that are
asset-sensitive, which means their interest-earning
assets reprice faster than their interest-bearing
liabilities. If interest rates were to increase
100 basis points, and a bank's costs of funding
or what they pay on deposits were also to increase
100 basis points, that would be a deposit
beta of 100%. But if interest rates increase 100
basis points, so that the rate they're charging
on loans increases 100 points, but the amount they
pay on deposits only increases 25 basis points,
that means their net interest spread increases 75
basis points.
A bank with a low deposit beta may be a
core banking franchise that has a lot of checking
accounts relative to savings accounts or
certificates of deposit. That's because people seek
out a high interest rate on savings, while checking
accounts usually pay nothing or almost nothing.
Lallos: Do financial companies disclose their level
of interest-rate sensitivity?
Wong: Interest-rate sensitivity disclosures
are not standardized and have their limitations,
but they are still a reasonable first step
in ranking relative exposures to changes in interest
rates. The most common disclosure by
financial firms is the effect on net interest
income of a 100-basis-point increase in the
interest-rate yield curve compared with a baseline
scenario. For firms with both large wealthmanagement
and investment banking segments,
the effect on total revenue from a 100-basispoint
rate increase is relatively small, frequently
in the low-single-digit percentage points,
so we don't expect significant benefits from
rising rates.
Lallos: What other factors do you look at when
assessing rate sensitivity?
Wong: Business models. There are differences in
the business model of an online bank versus
a traditional bank, for example. Why do people go
to online banks? Because for the most part, they
pay the highest interest rate. People go to
traditional banks because maybe they want to visit
a physical branch once in a while or because
they see the marketing of the physical
branch there. So online banks generally have a
higher deposit beta. They have to increase
the amount they pay on deposits along
with increases in the fed-funds rate or the overall
interest environment at a higher rate than
traditional banks do.
Among investment-services firms, there are
differences between an online brokerage
and a wealth-management firm. An online
brokerage will typically have a lower deposit beta.
If you sign up for an online brokerage
like Charles Schwab SCHW or E-Trade, you're
doing so primarily because you want to
invest in stocks or bonds or mutual funds. If you
have any cash in your account, that's cash
that is waiting to be invested. It's not like a
certificate of deposit that is going to be locked
up for three years or five years, where
you're looking for the highest interest rate.
1 Wong, M., Warren, G. & Bhatia, R. 2022. " Investment Service Companies for Your Interest Rate Outlook, " Morningstar. July.
morningstar.com/products/magazine
67
Wealth-management firms have different
client group demographics. These are usually
higher-net-worth individuals than the
typical brokerage account customer. If you have
low-single-digit thousands of dollars in your
brokerage account, whether you're getting paid
0.2% or 0.5% is probably not going to matter
too much. But if you're a high-net-worth individual,
and you have maybe $100,000 in cash, tens
of basis points might start to matter. If you have
a financial advisor who's actively managing
your account, they are looking to get as much
return as possible for you.
Lallos: In a recent white paper,1
you named Charles
Schwab as a top pick for rising interest rates
and noted that Goldman Sachs GS is less rate-sensitive.
What are the key differences that account for this?
Wong: Business mix matters a lot. More than 50%
of Charles Schwab's net revenue is related
to interest rates in one way or another, so rate
changes have a much greater effect on its
overall business. Goldman Sachs' interest revenue
percentage is around 10%.
Going back to the business model, Charles Schwab
is a brokerage; about half of its business is
online brokerage. (The other half is supporting
Registered Investment Advisors.) The
customers with all those brokerage accounts are
relatively interest-rate-insensitive, because they're
not looking at the rate paid on their cash.
I think that Charles Schwab still has quite a bit
more to go in its net interest income story
and its growth. There's the short end of the yield
curve and the long end of the yield curve. Charles
Schwab will benefit from the rise in shortterm
interest rates immediately. That's already
started to flow into their net revenue.
But Charles Schwab also has a banking business
with a lot of asset-backed securities, like
residential mortgage-backed securities, that will
take a longer time to reprice. I think they have an
average duration on their bond portfolio or
mortgage-backed securities portfolio of 4 to 4.5
years. So, roughly speaking, around 10%-20%

https://www.morningstar.com/stocks/xnys/gs/quote https://www.morningstar.com/stocks/xnys/schw/quote http://www.morningstar.com/products/magazine

Morningstar - Q4 2022

Table of Contents for the Digital Edition of Morningstar - Q4 2022