Why it Might Be Wise to Steer Clear of Bank Stocks and Other Lending Companies

Why shareholders of First National Financial Corp. (TSX:FN) and other financial institutions might want to consider selling their shares.

As interest rates continue to rise, borrowers are faced with rising costs, which could increase the risk of default. Although interest rates are still very low, many homeowners that locked in mortgages before the rate hikes occurred could see their costs rise when it comes time to renew.

Other consumers that are on variable rates have already seen their costs increase, although buyers on variable rates are subject to more difficult stress tests, making that segment less of a risk for financial institutions.

On Monday, MNP Ltd. released a survey which found that some Canadians claim to have already been impacted by the rate hikes, and 42% of those surveyed expressed concerns about having to go further in debt just to cover basic expenses.

The president of MNP, Grant Bazian, stated in a new release, “It’s clear that people are nowhere near prepared for a higher rate environment.”

What this means for lenders

With many Canadians already stretching their incomes to meet day-to-day needs, consumers with heavy debt loads could pose a significant default risk to banks and other lending companies. First National Financial Corp. (TSX: FN) is a non-bank lender with both corporate and residential customers and is one stock that could be adversely impacted from rising rates.

Commercial borrowers present a significant risk as well, and companies like Valeant Pharmaceuticals Intl Inc. (TSX:VRX)(NYSE:VRX) that carry lots of debt could see borrowing costs put further pressure on their financials. Valeant is also close to breaching its debt covenants, and further rate increases could put the company’s ability to meet those obligations in jeopardy.

Tighter mortgage rules will make financial stocks less appealing

Not only will lenders face a higher risk of default from borrowers, but the pool for new loans and mortgages will also be lower. Rising interest rates coupled with harsher stress tests for residential mortgages will likely result in banks and other lenders issuing fewer mortgages to consumers.

Although bank stocks have seen strong growth over the years and in recent quarters, that tide may be turning. In its most recent quarter, Royal Bank of Canada (TSX: RY)(NYSE: RY) saw its revenue from loans and leases rise 4% from the previous year, while Canadian Imperial Bank of Commerce (TSX: CM)(NYSE: CM) saw that segment grow by 12%.

In the trailing 12 months, over 80% of CIBC’s total interest income has come from loans and leases, while it has made up 70% of Royal Bank’s total. Banks certainly have a lot to lose if mortgages and loans start to decline, which, at this point, seems to be an inevitability.

Why investors should avoid financial stocks today

Although banks are generally safe investments and, over the long term, are able to see strong and stable growth, many are at or near all-time highs. A financial crisis could send the stocks for a big correction, and it may be a good time to sell any gains from financial investments before that time comes.

Not only are we facing a time when interest rates are rising, but consumer debt levels are going in the same direction as well. Oil and gas companies in Alberta are still fragile, and we could see even more corporate bankruptcies come as a result of more rate hikes.

Fool contributor David Jagielski has no position in any stocks mentioned.  Tom Gardner owns shares of Valeant Pharmaceuticals. The Motley Fool owns shares of Valeant Pharmaceuticals.

More on Bank Stocks

a person searches for information on the internet
Bank Stocks

Still Not Collecting Dividends? Here’s 1 Stock to Start With

This Canadian bank’s growing dividends, strong stock performance, and improving earnings could give new income investors an appealing place to…

Read more »

Group of people network together with connected devices
Bank Stocks

Everyone’s Snapping Up These Stocks: Should You?

These two popular Canadian financial stocks have already delivered strong gains, but their strong fundamentals suggest there is still plenty…

Read more »

coins jump into piggy bank
Bank Stocks

Thinking About Bank Stocks? Here’s What to Know in September

After a strong run so far this year, here’s what Canadian investors should know about the big bank stocks in…

Read more »

Fed Chairman Jerome Powell speaks with U.S. president Donald Trump
Stocks for Beginners

Bank Stocks Wilted After the Fed Raised Interest Rates: Is Now the Time to Buy the Big Six?

Why waiting before buying the Big Six may be a prudent move for Canadian investors.

Read more »

shopper carries paper bags with purchases
Stocks for Beginners

Are You Spending More Just to Use Your Credit Card Perks?

Credit-card rewards lose their appeal quickly when earning them pushes you to spend money you never planned to spend.

Read more »

young adult uses credit card to shop online
Stocks for Beginners

Credit-Card Rewards Keep Changing: What Does That Mean for Bank Stocks?

Changing credit card rewards show how hard Canadian banks are competing to attract spending and deepen customer relationships.

Read more »

dividend stocks bring in passive income so investors can sit back and relax
Bank Stocks

Is Your Premium Credit Card Still Worth the Annual Fee?

Scotiabank's premium-card offering currently charges $150 annually, includes six lounge visits, and waives the typical 2.5% foreign-exchange markup.

Read more »

Bank Stocks

The TSX Dividend Stock Built for People Who Want One Less Thing to Worry About

This established TSX dividend stock remains an income pillar for risk averse long-term investors.

Read more »