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Bank of America's unequaled hoard of non-interest-bearing deposits is the main reason the North Carolina-based bank is so much more sensitive to higher interest rates than its peers.
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It may come as little surprise to you that higher interest rates are good for banks' top and bottom lines. After all, one of the main ways banks make money is by underwriting loans, the price of which is tied to interest rates.
But this doesn't explain why some banks are more sensitive to rising rates than others. I'm talking specifically about Bank of America (BAC +0.00%).
In its latest quarterly regulatory filing, Bank of America estimates that a 100-basis-point increase in interest rates would translate to an added $5.3 billion worth of net interest income. The corresponding figures at JPMorgan Chase (JPM +0.00%) and Citigroup (C +0.00%) come out to $2.8 billion and $2.0 billion, respectively.
There are a handful of reasons that explain why Bank of America's top line is twice, if not more, sensitive to higher rates than that of its peers, but one of the most important stems from its unequaled hoard of non-interest-bearing deposits.
Data source: Quarterly earnings supplements. Chart by author.
In the third quarter, which ended on Sept. 30, Bank of America had an average balance of $439 billion in non-interest-bearing deposits. That compares to $409 billion at JPMorgan Chase and a paltry $41 billion at Citigroup -- I also included Wells Fargo in the chart, but because it isn't as transparent in its regulatory filings about its interest rate sensitivity, I've otherwise excluded the California-based bank from this discussion.
For Bank of America, this means that when interest rates rise, the amount of additional revenue it generates from its loan and securities portfolios outstrips the amount of additional interest expense it must pay on its liabilities. The effect is similar in one regard to that of operating leverage -- growing revenue faster than earnings.
And Bank of America's added revenue from higher rates not only outstrips its added interest expense, but it does so to a greater extent than at JPMorgan Chase and Citigroup. This is because, on a relative basis, a larger share of Bank of America's funds are made up of non-interest-bearing deposits than at these other two banks.
As you can see, nearly a quarter, or 23%, of Bank of America's funding sources don't bear interest. That compares to 18% at JPMorgan Chase and only 2.5% at Citigroup.
This logically goes a long way toward explaining why Bank of America's shares have outperformed those of its peers since the outcome of the presidential election seems to have convinced analysts, investors, and economists that higher interest rates are on the near-term horizon. If this prediction comes to fruition, Bank of America will be the biggest beneficiary in its peer group.