Steady rate increases could be great for banks

Steady interest rates could be a shot in the arm for spread-based businesses like banks, says Aylon Ben-Shlomo, principal and client portfolio advisor with Los Angeles-based Aristotle Capital Management.

As the era of ultra-low interest rates appears to be coming to an end, the pace of rising rates will be a key factor in who benefits, Ben-Shlomo said.

“If we see a healthy economy and interest rates increasing because the rate of growth is increasing, that’s a good thing for lenders, who are eager to lend more,” he said. “If we see interest rates [become] more volatile and gap up, that could be a challenge for spread-based businesses, as their books reset quickly.”

He said his team is keeping a close eye on how and why interest rates move.

“Ultimately, the focus on interest rates is something that boils down to each specific business model,” he said.

Aristotle now has more exposure in the financial sector than it has traditionally had, Ben-Shlomo said. As the economy wakes up after the Covid shutdowns, he has taken a shine to companies like Virginia-based Capital One Financial Corp., a credit card provider.

“The consumer is healthy and the consumer is spending,” he said. “And that’s something that could benefit Capital One over time, as well as a few regional banks that we’re invested in, such as PNC Bank.”

Aristotle has also invested in Cincinnati Financial Corp., a property and casualty insurer based in Ohio. Ben-Shlomo said Cincinnati Financial has developed a high-service, high-touch network of over 1,700 independent agents who can handle claims quickly and accurately. This delivers higher market share, better loss ratios, and allows for better premium pricing.

“This is a business that is very strong financially, differentiated in terms of their operating structure, and from a valuation perspective, we think is quite attractive.”

The cost of money

The prospect of rising interest rates could spell trouble for highly leveraged companies in other industries, especially ones that cannot easily adjust their product pricing to meet the challenge of higher rates.

For example, Aristotle recently sold its holdings in Texas-based Pioneer Natural Resources Co. after assessing the debt load it took on in acquiring Parsley Energy Inc. last year.

“When you’re selling oil, you have significant operating leverage in your business because you can’t influence the price of oil. It makes sense for a business that has meaningful operating leverage to perhaps have less financial leverage,” Ben-Shlomo said. “When you have both, the magnitude of success or failure is increased.”

He said some businesses — like real estate companies — can and should have sufficient financial leverage to operate where property values are escalating.

In particular, Ben-Shlomo likes Michigan-based Sun Communities Inc. and Illinois-based Equity Lifestyle Properties Inc. — two businesses that have established footholds in areas where it’s difficult to obtain permits for new manufactured housing communities.

“Oftentimes, debt is viewed as a four-letter word. And, in our eyes, it shouldn’t be. Prudent use of leverage can be beneficial for a business,” Ben-Shlomo said.

The long-term impact of fiscal stimulus and monetary support on the U.S. economy remains “a big question mark,” Ben-Shlomo said.

He said the government intervention was clearly necessary, but markets don’t always react in predictable ways, and there could be long-term implications that have yet to be revealed.

“There will be winners and losers,” he said. “It’s too soon to tell which are which.”

Among the unknowns are how public attitudes toward government involvement in healthcare could change in the wake of the all-consuming Covid crisis.

“We’re seeing [a natural experiment] with a single-payer healthcare system,” Ben-Shlomo said. “The Covid vaccine is something that this country has rolled out for free to its citizens, and for many people, it’s their first experience with a single-payer healthcare system.”

The experience could soften people’s opposition to socialized healthcare, could spark new conversation, and potentially lead to grand policy changes.

“It’s something to pay attention to,” Ben-Shlomo said.

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.