What If Short-Term Rates Rise?
The "ebrokers are most levered to higher short-term rates as much of the client cash is invested relatively short term," Meredith said. "With average durations of ~2 years, longer-term rates will also have an impact as the portfolio rolls over. We estimate that a 200bps rise in the Fed funds rate would increase SCHW's earnings by about 115%. The impact for AMTD is somewhat lower at 45%."
- Bank of New York Mellon (BK). Meredith said that "BK has a highly asset sensitive balance sheet, which will drive margin and net interest income as rates," and that the company "has an added benefit of recouping waived money-market fees upon the first 25bp rise in short-term rates." UBS estimates that a rise in short term rates of 100 basis points would lead to a 10% increase in earnings per share for the company.
- Comerica (CMA). Calling the Dallas lender "the most sensitive to interest rates" among the mid-cap banks covered by his firm, Meredith estimates that "an increase of 200bp in
short-term rates would result in a 10% increase in Net Interest Income"
- Morgan Stanley (MS). The company's plan to complete its purchase of Citigroup's stake in the Morgan Stanley Smith Barney joint venture this year will cause its deposit base to "roughly double" according to UBS, "thus increasing MS's asset sensitivity (exposure to higher short-term rates via its deposit spread)."
- Aon PLC (AON). The company would be expected to benefit from increased fiduciary income.
- RenaissanceRe Holdings (RNR). Meredith said that "higher interest rates would give a relatively fast boost to net investment income," because of the company's "very short asset duration."
Top Picks for Rising Long-term Rates
UBS sees life insurers as the strongest group in its "base case" scenario for rising long-term rates, with short-term rates staying at or near their historically low levels through 2014. Meredith said that "higher long-term interest rates would provide some relief from the downward pressure in recent years on life insurers' portfolios yields and investment spreads," although the improvement in earnings would be gradual, because of the relatively long durations of the companies' investment portfolios. "Therefore, we see sentiment improvement as the main driver of life insurance stock outperformance in a scenario of higher long-term interest rates." Here are the three insurers that Meredith said would fare the best in UBS's rising long-term rate scenario:
- Lincoln National (LNC) and Unum Group (UNM). Meredith said that since rising long-term rates would benefit all life insurers, "we prefer companies that can generate strong, above-peer book value per share (BVPS) growth, supported by stable operating and net ROEs and aggressive capital management," which would "support the stock prices of LNC and UNM even if interest rates fall and multiples contract."
- The Hartford Financial Services Group (HIG). Meredith said that "higher interest rates likely wouldaccelerate the run-off of the company's annuities business (thus improving the perceived risk profile)."
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