Interest rates

Higher interest rates are perfect for this action

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 bring inflation under control. It would be the first interest rate hike since the start of the coronavirus pandemic about two years ago, when the Fed cut the federal funds rate to the range of 0.00% to 0.25. %.

That’s not exactly good news for many businesses, as it means the cost of borrowing will go up, but some businesses will be grateful. Banks, for example, prefer higher interest rates because they lend the most, and higher interest rates allow them to take advantage of the gap between the interest they pay to creditors and to account holders and the interest they receive on the loans. One bank, in particular, which is about to benefit from higher interest rates is Capital One Financial ( COF -2.12% ).

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Credit card revenue jumps in fourth quarter

Capital One is the 10th largest bank in the United States, with approximately $381 billion in assets under management as of December 31. But it is best known as a credit card company as it is one of the major credit card issuers in the country.

Capital One earned about 63% of its $8.1 billion in fourth-quarter revenue from its credit card segment, with 28% from its traditional consumer banking business and the remainder, about 9%, from the commercial bank. Overall, revenue grew 4% year-over-year in the fourth quarter.

Loans rose 6% year over year in the fourth quarter to $115 billion, with credit card loans jumping the most (9%). Credit card revenue grew 15% year over year to $5.1 billion.

Net interest income (NII) – the amount of income earned from interest less expenses paid on interest-bearing products – rose 8% in the year-over-year quarter to 6.1 billion dollars, and 106% for all of 2021 to $26.1 billion.

Net interest margin – the difference between interest received and interest paid – rose to 6.6% from 6% a year ago. That’s about twice the margin of an average bank. It’s higher because Capital One derives most of its revenue from credit cards, which carry higher interest rates.

That margin should widen further this year as Capital One enters a period where we should see a long period of steady interest rate hikes, including about four to seven this year.

Interest rate hikes will boost net interest income

Capital One’s share price is down about 8% in 2022 through March 9, but most of the decline has occurred in the past two weeks, coinciding with the invasion of the Ukraine by Russia. Last year, the stock price increased by 49%. And this year, the consensus price target over the next 12 months is $185 per share, which would represent a gain of about 40% from its current price.

The reason has a lot to do with rising interest rates, as CFO Andrew Young said on the fourth quarter earnings call. “As rates rise, [it] clearly will be a tailwind for NII,” Young said. $500 million, Young said.

Additionally, economic growth, low unemployment, and the end of COVID-19 mandates are expected to lead to increased consumer spending, which means higher credit card balances. This, in turn, would increase the net interest margin. It would also keep the net charging and delinquency rates low. Currently, Capital One has a write-off rate (bad debt written off as a loss) of 0.79%, which is very low, and a 30-day default rate of 2.25%, down from 2.41% in the fourth quarter of 2020.

The projections could change if inflation does not come down as expected. And a protracted conflict in Ukraine could change all expectations.

There’s a lot of uncertainty right now, but one thing that’s almost certain is that the Fed will raise interest rates, and that will be good for Capital One.

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