After two years of extremely low interest rate environment, Bank of America (Bac -2.37%) He had high hopes for the credit work coming in the year.
Not only does America’s second-largest bank believe that asset trading may finally pick up, but the Federal Reserve is expected to raise interest rates to combat some of the highest inflation seen in decades.
The Fed didn’t just raise rates, it raised them more forcefully than anyone could have predicted at the start of the year. This allows Bank of America’s management of the loan and securities business to perform better than originally thought. Let me explain.
Net interest income is increasing.
A major component of any banking business is a source of income called net interest income (NII), which is the profit banks make on loans and securities after covering the costs of financing those assets.
Most banks will benefit in a bullish environment because yields on many loans and securities will be higher when the Fed raises rates. The yield on bank deposits will also be higher, but in a more muted way, especially if the bank has good sticky and low-cost deposits. Bank of America has one of the best in the business, at least compared to other big banks. With the federal funds rate now in the 3% and 3.25% range, Bank of America is starting to see the upside for Bituah Leumi.
Image source: Bank of America
Additionally, we already know from Bank of America’s second quarter earnings call that the NII is only expected to improve in the middle of the year, as the Fed has become more aggressive with rate hikes in June, July and now September meetings. .
Bank of America CFO Alastair Borthwick told analysts on the Q2 earnings call that, given moderate loan and deposit growth and deposit rates, the B.I.E. The bank raised $900 million to $1 billion from the $12.5 billion it generated in Q2. . Borthwick then said management expects NII to grow more rapidly in the fourth quarter. When an analyst asked if the bank could exit Q4 with a $15 billion NII run rate, Borthwick said it was too early to say, but he didn’t know that either.
This guidance is provided after the end of Q2. Today, interest rates are now expected to end the year higher than they were in July when the conference call took place. At the September meeting, the Fed raised the federal funds rate another 0.75%, and the Fed’s median forecast is that the benchmark rate will end the year at 4.4%. That suggests another rate hike of 0.75% and a half-point increase at the Fed’s two remaining meetings this year.
Bank of America did not provide estimates in July. But on its July second quarter earnings call, JPMorgan Chase He said the federal funds rate is expected to end the year at 3.5%, which is likely to be where the Bank of America is targeting.
On a conference call last week, Borthwick confirmed the bank’s guidance from Q2 and said that, if anything, the outlook for Bituah Leumi “has moved a little bit more positively, and our deposit beta experience was probably a little bit better than we thought.”
What about the current environment?
It is true that the economic outlook is challenging and that a deeper recession seems inevitable in the near future. Like other banks, Bank of America’s investment banking business has seen significant success from initial public offerings and the lack of other offerings. Mortgage banking is also being hit by rising rates, and a sharp recession could slow credit growth and consumer spending.
But at Bank of America, a large part of the betuah leumi comes from pouring excess liquidity into bonds, which have pushed their yields up by the federal funds rate. And although loan losses are expected to increase at some point, they are now surprisingly low.
Banks have not experienced such rate growth since before the Great Recession as the business environment became difficult. As such, I expect Bank of America to finish the year strong as it enters Bituah Leumi, and the earnings line will come in higher 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 the mentioned stocks. The Motley Fool recommends JPMorgan Chase. The Motley Fool has a disclosure policy.
