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Interest rates remained near all-time low levels between 2009 and 2021, thus providing a strong headwind to the net interest margin of banks, i.e., the difference between the interest rate they charge on their loans minus the interest rate they pay on their deposits. However, this has changed this year, as the Fed is raising interest rates aggressively in an effort to put a lid on inflation, which has skyrocketed to a 40-year high. This is a game-changer for most banks. In this article, we will discuss the prospects of three dividend stocks that greatly benefit from rising interest rates.
 

JPMorgan & Chase (JPM)

JPMorgan was founded in 1799 as one of the first commercial banks in the U.S. Since then, it has merged or acquired more than 1,200 different institutions and thus it has created a global banking behemoth, with a market capitalization of $393 billion. JPMorgan competes in every major segment of financial services, including consumer banking, commercial banking, home lending, credit cards, asset management, and investment banking.

JPMorgan was temporarily hurt by the Great Recession, the worst financial crisis of the last 90 years, but it emerged stronger from that crisis, in contrast to many banks, which incurred irreversible losses. Its resilience in that recession is a testament to the quality of management and its prudent execution. If the aggressive interest rate hikes implemented by the Fed cause a recession, JPMorgan is likely to endure such a recession without any problem. In addition, JPMorgan enjoys significant competitive advantages, such as its enormous scale, its diversified revenue streams, and its world-class reputation.

Although interest rates remained depressed throughout the decade leading to 2021, JPMorgan exhibited positive business performance during this period. Last year, the bank posted record earnings per share of $15.25 but mostly due to extremely high reversions of loan loss provisions amid the strong recovery of the economy from the pandemic. As these reversions are non-recurring, JPMorgan is expected to post earnings per share of $11.60 this year. While these earnings per share are much lower than the blowout earnings in 2021, they still mark the second-best performance of the bank in its history.

Based on these results, JPMorgan has grown its earnings per share by 8.4% per year on average over the last decade. This performance, which resulted primarily from the sustained economic recovery from the Great Recession, is certainly satisfactory, especially given the depressed interest rates that prevailed throughout this period.

Going forward, the company enjoys a strong tailwind, namely the environment of rising interest rates. This environment enhances the net interest margin of banks and thus increases their earnings significantly. The positive effect of rising interest rates was evident in the latest earnings report of JPMorgan. The company saw its net interest income grow 16% over the prior year’s quarter and posted earnings per share of $3.12, one of the best performances in the history of the bank.

JPMorgan has raised its dividend for 11 consecutive years and is currently offering a 3.0% dividend yield. Given its healthy payout ratio of 35%, its solid business momentum, and its resilience to recessions, the bank is likely to continue raising its dividend for many more years.
 

State Street Corporation (STT)

State Street Corporation is a financial services company which is based in Boston and traces its roots back to 1792. It is one of the largest asset management firms in the world, with $3.3 trillion of assets under management and $36 trillion of assets under custody and administration.

State Street benefits from economies of scale, which pose a barrier to new entrants. However, competition with financial behemoths like Vanguard, BlackRock, and Bank of New York Mellon, which are lowering fees to attract investor funds, limits the growth potential of this business.

On the bright side, State Street has an exceptional performance record. To be sure, the company has grown its earnings per share in 8 of the last 9 years, at a 6.7% average annual rate. The growth pace combined with the consistency of the company are testaments to its solid business model. Moreover, the bank has ample room for future growth thanks to rising interest rates and potential acquisitions of smaller competitors.

State Street has grown its dividend for 13 consecutive years and is currently offering a 3.2% dividend yield. The bank has grown its dividend by 10.0% per year on average over the last decade and by 8.5% per year on average over the last five years. Given its payout ratio of 34% and its proven resilience to economic downturns, the company is likely to keep raising its dividend meaningfully for many more years.

It is also worth noting that State Street is currently trading at a nearly 10-year low price-to-earnings ratio of 10.5. Given all the above strengths of the company, the stock is likely to highly reward those who purchase it around its current price in the upcoming years.
 

KeyCorp (KEY)

Based in Cleveland, KeyCorp has been in business for more than 190 years and is now one of the largest bank-based financial services companies in the U.S., with $190 billion in assets. The company operates in 15 states, with approximately 1,300 ATMs and 1,000 full-service branches. KeyCorp works in personal, small business, commercial and corporate banking as well as in wealth management.

KeyCorp has exhibited decent business performance over the last decade. During this period, the company has grown its earnings per share at a 9.8% average annual rate. In addition, the bank greatly benefits from rising interest rates. In the third quarter, it enhanced its net interest margin from 2.47% in the prior year’s quarter to 2.74% and thus it is on track to post its second-best earnings per share in the last decade this year.

KeyCorp is also offering a 4.1% dividend yield, which is much higher than the yields of JPMorgan and State Street. However, it is critical to realize that KeyCorp is much more vulnerable to recessions than the other two banks. In the Great Recession, KeyCorp was caught off-guard and thus it incurred excessive losses. It also more than doubled its share count in order to remain liquid. As a result, its shareholders incurred excessive losses in that crisis. To provide a perspective, KeyCorp is still trading approximately 50% lower than its pre-crisis high.
 

Final Thoughts

After several years of depressed interest rates, banks enjoy a strong tailwind in their business thanks to the rate hiking cycle implemented by the Fed. Therefore, investors should focus on the financial sector to identify some attractive stocks for their portfolios. JPMorgan and State Street are highly attractive right now thanks to their promising growth prospects and their solid business models. KeyCorp is offering a much higher dividend yield but it is much more vulnerable to recessions than the other two companies.

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