1 Reason to Be Bullish on Bank of America Stock

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There are a number of reasons that investors should be bullish on Bank of America's (BAC -0.27%) stock, but the prospect of higher interest rates is the biggest of all. In fact, even if rates stay where they are today, following the increases at the end of 2016, the North Carolina-based bank should benefit immensely this year.

The benefit to Bank of America

It isn't hard to quantify how much Bank of America stands to gain, as it's laid out clearly in the bank's regulatory filings. As of the end of September, Bank of America estimated that a 100-basis-point increase in short- and long-term rates would translate into an additional $5.3 billion worth of net interest income in the following 12 months. This is high-margin revenue that, absent corporate income taxes, should largely fall to the bank's bottom line.

Since then, both short- and long-term rates have in fact gone up. Long-term rates surged by as much as 100 basis points between the end of September and the middle of December, though they've since settled at about 80 basis points higher. And short-term rates climbed 25 basis points following the Federal Reserve's monetary policy meeting in December.

Given that rates didn't adhere precisely to Bank of America's interest rate sensitivity analysis, as neither short- nor long-term rates are currently 100 basis points higher, it won't benefit from the entire $5.3 billion boost to its top line. As things stand today, it will instead see about half that, or $2.4 billion. On a quarterly basis, that equates to $600 million worth of additional net interest income that shareholders can expect it to earn between now and the end of this year.

An important clarification

But even though this seems clear, there is one outstanding question: When Bank of America says it will earn an extra $600 million in quarterly net interest income, what's that in addition to? Is it on top of its net interest income from the third quarter of last year, which was $10.2 billion? Is it on top of its fourth-quarter figure, which was $10.3 billion? Or is it in addition to some other number?

The answer is that it's on top of Bank of America's fourth-quarter net interest income. Here's how this plays out:

Data source: Bank of America.

Two points are worth mentioning here. The first is that interest rates will have to stay at or above where they were at the end of last year in order for these forecasts to come to fruition. If rates fall, which seems unlikely but you never know, then Bank of America wouldn't realize the full benefit.

The second point is that, assuming rates don't fall, these estimates should be viewed as a floor, not a ceiling. That is to say that Bank of America's actual quarterly net interest income could very well end up higher, as the bank continues to grow its loan portfolio. The Fed could also raise rates further, as it expects to do.

But even in the absence of growth, the trend in interest rates is auspicious for Bank of America. It earned $4.3 billion in the fourth quarter of last year. Tack on another $400 or so million in after-tax net income, holding all else equal, and the bank's bottom line should be up 10% or so throughout the four quarters of 2017.