After two years of ultra-low interest rates, bank of america (back -2.37%) had high hopes for its lending business this year.
The second-largest U.S. bank by assets not only believes business activity may eventually pick up, but also sees the Federal Reserve hit its highest level in decades. I expected to raise interest rates to combat inflation.
Not only has the Fed hiked rates, it’s done so much more aggressively than anyone expected at the start of the year. This could result in Bank of America’s loan and securities businesses performing even better than management originally believed. Please let me explain.
Increased net interest income
An important part of a bank’s business is its revenue stream, called Net Interest Income (NII). This is the profit a bank makes on a loan or security after covering the cost of funding the asset.
Most banks tend to benefit in a rising rate environment as yields on more loans and securities rise as the Fed raises rates. Yields on bank deposits will rise as well, but in a more conservative fashion, especially if the bank has a stable low-cost deposit base. Bank of America is he one of the best banks in the business, at least compared to other big banks. With the Federal Fund Rate currently in the 3% to 3.25% range, Bank of America has already started to benefit his NII.
Additionally, Bank of America’s second quarter earnings report suggests that NII is expected to improve only in the second half of the year. This is because the Fed has only gotten more aggressive in raising rates at his June, July and he September meetings. .
Alastair Borthwick, CFO of Bank of America, told analysts on the second-quarter earnings call that, assuming moderate loan and deposit growth and deposit pricing discipline, NII in the third said it would increase $900 million from the $12.5 billion of NII the bank generated in the second quarter to $1 billion. Mr Borthwick then said management said he expects NII to grow at an even faster pace in the fourth quarter. When analysts asked the bank if he could end the fourth quarter at the $15 billion NII run rate, Borthwick said it was too early to tell, but didn’t rule it out either.
This guidance was provided after the end of Q2. Today, interest rates are expected to end the year even higher than in July, when the conference call took place. At its September meeting, the Fed raised the federal funds rate by another 0.75%. The Fed’s median forecast calls for the benchmark rate to end the year at 4.4%. That means an extra 0.75% rate hike and a 0.5 point hike at his remaining two Fed meetings this year.
Bank of America did not provide interest rate assumptions in July. However, in the second quarter results announcement in July, JP Morgan Chase The Federal Funds Rate is expected to end the year at 3.5%, which Bank of America has likely pegged.
At a recent meeting last week, Borthwick confirmed bank guidance from the second quarter and said, if anything, the NII outlook “moves slightly positive and the deposit beta experience is It’s in line with what we had in mind, or maybe even slightly better.”
How is your current environment?
It is true that the economic outlook is becoming increasingly difficult and that a deeper recession seems inevitable in the near future. Like all banks, Bank of America has seen its investment banking business take a hit from the lack of initial public offerings and other issuances. Mortgage banks have also been hit by rising interest rates, and a deep recession could depress loan growth and consumer spending.
But most of Bank of America’s NII comes from investing excess liquidity in bonds, and bond yields have risen along with the federal funds rate. And while bad debt costs are expected to increase over time, they are still incredibly low at the moment.
Amid an increasingly severe business environment, banks have not seen interest rate rises like this since before the Great Recession. As such, Bank of America expects to end the year on a strong note for NII, which could result in a better-than-expected earnings line.
JPMorgan Chase is an advertising partner for The Motley Fool’s Ascent. Bank of America is the Motley Fool’s advertising partner for his The Ascent. Bram Berkowitz has no positions in any of the mentioned stocks. The Motley Fool recommends JPMorgan Chase. The Motley Fool’s U.S. headquarters has a disclosure policy.