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Analysts and commentators are becoming increasingly confident that the Federal Reserve will raise interest rates before the end of the year. This is good news for bank stocks, and Bank of America (BAC -1.30%) in particular, which stands to generate more revenue over the next 12 months if the central bank does so.
Roughly half of a big and well-diversified bank's net revenue comes from interest payments on loans and bonds. Because of this, it's axiomatic that higher interest rates will translate into higher revenue.
You can get a sense for how much a rate hike will help Bank of America by looking at its latest quarterly filing with the Securities and Exchange Commission. In it, the North Carolina-based bank estimates the impact on its net interest income from a 100 basis point increase in short-term rates, long-term rates, and both short- and long-term rates combined, respectively.
Here's how this breaks down:
|
Change in Rates |
Additional Net Interest Income Over the Next 12 Months* |
|---|---|
|
Short-term rates: +100 basis points |
$3.1 billion |
|
Long-term rates: +100 basis points |
$4.5 billion |
|
Short- and long-term rates: +100 basis points |
$7.5 billion |
*These figures have changed slightly over the last three months, but based on statements from Bank of America's executives on its latest earnings call, they're still a relatively accurate approximation for how higher rates will impact the bank's top line. Data source: Bank of America's Q2 2016 10-Q, page 107.
This is helpful information, but it's nevertheless important to appreciate that it's unlikely the Fed will raise rates by 100 basis points in one fell swoop. It's instead more likely to do so by 25 basis points, just as it did at its final meeting in 2015. Moreover, the Fed's monetary policy has the most potent impact on short-term rates.
Given this, the most pertinent question for investors right now is: How much will a 25 basis point boost to short-term rates help Bank of America?
Fortunately, thanks to an analyst's question about this very thing on Bank of America's third-quarter conference call, we have a pretty good idea. Here's the relevant exchange:
Analyst: Can you help us try to translate your 100-basis-point rate sensitivity into something closer to what one Fed hike might do for your net interest income?
Paul Donofrio, CFO of Bank of America: Sure. I can help you through that. So if you look about a 25-basis-point increase, that would be one quarter of our $5.3 billion in sensitivity.
If you want to assume that 25 basis points increases the long end by 25 basis points you know the answer. You can roughly take a quarter of it, perhaps even a little bit more, because we're probably more asset sensitive on the first 25 than the last 25 of that 100.
But if you don't want to increase on the long end just look at the short end. We've disclosed it's $3.3 billion. You can divide that by four and get a pretty good sense of what 25 basis points would do over the subsequent 12 months.
In other words, assuming that the Federal Reserve raises short-term rates by 25 basis points before the end of the year, then Bank of America would earn something like $825 million more over the next year in net interest income. That would translate into an approximately 2% boost to its net interest income given the run-rate from its most recent quarter.
That isn't enough to return Bank of America to its glory days prior to the financial crisis, but it'd certainly be a welcome development for investors who have long pined for the bank's profitability to improve.
