After two years of an ultra-low interest rate environment, Bank of America (BAC -1.50%) had high hopes for his loan business at the start of the year.
Not only did the second-largest US bank by assets thought business activity could finally pick up, but it also expected the Federal Reserve to raise interest rates to combat some of the highest levels of inflation. high observed for decades.
The Fed not only raised rates, it raised them aggressively, far more than anyone probably imagined at the start of the year. This could allow Bank of America’s lending and securities business to perform even better than management initially thought. Let me explain.
Net interest income up
A key part of any bank’s business is a source of income called net interest income (NII), which is the profit banks make on loans and securities after covering the cost of funding those assets.
Most banks tend to benefit from a rising rate environment as yields on more of their loans and securities will rise as the Fed raises rates. A bank’s deposit yields will also increase, but more moderately, especially if a bank has a good, stable, low-cost deposit base. Bank of America is one of the best in the industry, at least compared to other major banks. With the federal funds rate now in a range of 3% and 3.25%, Bank of America has already started to see the benefits for NII.
Additionally, we already know from Bank of America’s second quarter earnings call that the NII is only expected to improve in the second half of the year as the Fed has only become more aggressively with rate hikes at its June, July and now September meetings. .
Bank of America Chief Financial Officer Alastair Borthwick told analysts on the second-quarter earnings call that assuming modest loan and deposit growth and disciplined deposit pricing, the NII in the third quarter would increase by $900 million to $1 billion from the NII’s $12.5 billion generated by the bank in the second quarter. . Next, Borthwick said management expects NII to grow at an even faster pace in the fourth quarter. When an analyst asked if the bank could emerge from the fourth quarter with an NII run rate of $15 billion, Borthwick said it was too early to tell, but didn’t rule it out either.
These indications were provided after the end of the second quarter. Today, interest rates are expected to end the year even higher than they were in July when the conference call took place. At its September meeting, the Fed raised the fed funds rate another 0.75%, and the Fed’s median forecast is that its benchmark rate will end the year at 4.4%. This implies another 0.75% rate hike and a half point hike at the last two Fed meetings this year.
Bank of America did not provide rate assumptions in July. But on its July second-quarter earnings call, JPMorgan Chase said he expected the federal funds rate to end the year at 3.5%, which is likely where Bank of America had set it.
At a recent conference call last week, Borthwick confirmed the bank’s guidance from the second quarter and said that, if anything, NII’s outlook has “moved slightly positively, and our beta experience of filing has been consistent or maybe even slightly better than we thought”.
What about the current environment?
It is true that the economic outlook is becoming more difficult and that a deeper recession in the near future seems increasingly inevitable. Like all banks, Bank of America has seen its investment banking business suffer from a lack of IPOs and other issuances. Mortgage banking is also hurt due to rising rates, and a severe recession could lower loan growth and consumer spending.
But much of Bank of America’s NII comes from investing excess cash in bonds, whose yields have risen with the federal funds rate. And while loan losses are expected to increase at some point, they are still incredibly low right now.
As the business environment becomes increasingly difficult, banks have not seen such a rate hike since before the Great Recession. As such, I expect Bank of America to end the year strong on the NII and potentially see this revenue line better than expected.
JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool recommends JPMorgan Chase. The Motley Fool has a disclosure policy.