Morningstar - Q4 2022 - 68

Investors
EXHIBIT 1
of the portfolio matures every year and they
can then take that cash and reinvest it.
That means that the benefit that they have from
higher interest rates will play out over
multiple years, because that's related to the long
end of the interest-rate yield curve, and
because as a portion of the portfolio matures,
they can reinvest at a higher rate.
Lallos: How does Goldman Sachs' business
model compare?
Wong: Goldman Sachs has Marcus, which is their
online bank, and they gain deposits by paying
a fairly high interest rate. That means their deposit
beta is higher, so they're not going to keep
as much of the increasing interest rates as Charles
Schwab will. Also, some of their other deposits
come from corporate clients, which tend to
be more active in gaining the highest rate that
they can get on their cash balances. So, business
mix and business model are two differences.
But note that even though Goldman Sachs
is relatively rate-insensitive for a financial-services
company, most companies in almost every
sector outside of financial services would be
relatively interest-rate-insensitive.
Goldman Sachs, like other investment banks,
faces headwinds. Investment banking and trading
revenue was abnormally high in 2020 and 2021
and should normalize lower over the next couple of
years, which will offset much of any benefit
from higher interest income. That said, we believe
much of this normalization is already factored
into the stock's price. The company is only
modestly interest-rate-sensitive, so not much of its
valuation is dependent on interest rates climbing
and remaining high. In the medium term, the
market may reward the company for initiatives that
should improve the stability of its earnings, such
as its push into consumer banking and changes in
its investment-management business.
Lallos: You've singled out LPL Financial LPLA as another
name that benefits from rising rates.
Wong: The thing about LPL Financial is that a very
large portion of its interest-rate sensitivity
is just to the short end. LPL may have some of the
highest exposure in the near term to higher
interest rates. LPL would be for people that have
a very strong view of higher short-term interest
68
Morningstar Q4 2022
Reflecting Rates Financial companies that benefit most from rising rates are closer
to fairly valued.
Name
BlackRock BLK
Charles Schwab SCHW
Citigroup C
Federated Hermes FHI
LPL Financial LPLA
Goldman Sachs GS
Economic
Moat
Wide
Wide
None
None
Price ($) Fair Value ($)
550.28
71.87
41.67
33.12
850.00
84.00
78.00
33.00
Narrow 218.48
Narrow 293.05
Source: Morningstar Direct. Data as of 09/30/2022.
256.00
438.00
P/FV
Morningstar
Rating
0.65 QQQQQ
0.86 QQQ
0.53 QQQQQ
1.00 QQQ
0.85 QQQ
0.67 QQQQQ
Market Cap ($B)
82.96
136.34
80.70
2.95
17.43
100.03
rates, because LPL should have a higher
increase in earnings from short-term interest rates
going high and staying there. That said, LPL
Financial is not as diversified of a company as
Charles Schwab, so for more risk-averse
investors or people who want to invest in mainly
large caps, Charles Schwab would potentially
be more appropriate. But if interest rates start
falling in the back half of 2023 or early 2024,
then LPL would probably have a more significant
earnings decline than, let's say, Charles Schwab
that could benefit even if short-term interest
rates fall, because that portion of their portfolio
tied to long-term interest rates will keep on
repricing as long as long-term interest rates maybe
stay at 3%, 3.5%, or higher instead of falling
back down to, say, 2%.
Lallos: Higher interest rates are positive for
many companies in the financial sector-but will this
trend persist?
Wong: The more rapid increase and higher
expected level of medium-term interest rates have
increased the probability that the United States
will enter a recession. We had already expected
that earnings for many financial companies would
normalize lower over the next couple of years, as
2021 earnings were elevated from strong mortgage
refinancing, investment banking, and trading
revenue along with negative loan-loss provisioning.
While we project earnings will face some
near-term pressure, we believe much of this is
already priced into financial sector stocks and that
many are undervalued on a long-term basis.
Lallos: Any other picks worth mentioning?
Wong: BlackRock BLK has traded off harder than
other asset managers this year, but there's
no fundamental reason for this. The company is at
its core a passive investor. Through its iShares
exchange-traded fund platform and institutional
index fund offerings, the wide-moat firm sources
two thirds of its managed assets (and half
its annual revenue) from passive products. In an
environment where investors are seeking
out passive products, as well as asset managers
that have greater scale, established brands,
solid long-term performance, and reasonable fees,
BlackRock is well positioned.
As of the end of September, Citigroup C is the
most undervalued traditional U.S. bank under our
coverage. It's trading below tangible book value.
Citigroup is not one of the most rate-sensitive
names, which we think contributes to its current
lack of popularity. But the bank is shedding
nonperforming segments and refocusing its
operations on core competencies and geographies.
We think this and an eventual resolution of
consent orders from regulators will serve as future
catalysts. While Citigroup faces some headwinds,
an eventual recovery in card balances will
help drive revenue growth. K
Laura Lallos is managing editor of Morningstar magazine.
https://www.morningstar.com/stocks/xnys/blk/quote https://www.morningstar.com/authors/44/laura-lallos
Morningstar - Q4 2022

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