For bank investors right now, there are few things more important than the direction of interest rates. The higher rates climb, the more money banks will make.
Bank of America (NYSE:BAC) serves as a case in point.
Every quarter, the nation's second-biggest bank by assets publishes an interest rate sensitivity analysis in its 10-Q. The analysis looks at six different scenarios, which you can see in the table below, taken from Bank of America's filing:
You can break this table down by looking at the three scenarios where interest rates rise versus the three scenarios where interest rates fall.
The impact of higher rates
In all three of the scenarios where interest rates rise, so too does Bank of America's net interest income. The biggest boost comes from a 100-basis-point increase in both short- and long-term interest rates. That would yield $3.2 billion in added net interest income.
The amount of additional net interest income isn't as resplendent if only short-term rates rise by 100 basis points. In that case, Bank of America would earn an added $2.2 billion in net interest income. Alternatively, if long-term rates climb by 100 basis points while short-term rates stay put, then the Charlotte, North Carolina-based bank estimates that it'd earn an extra $1 billion in net interest income.
What this tells us is that Bank of America's top line is roughly twice as sensitive to changes in short-term interest rates relative to long-term rates.
The impact of lower rates
In the three scenarios where interest rates fall, on the other hand, Bank of America's net interest income is projected to follow suit. Where both short- and long-term rates decline by 50 basis points, Bank of America's net interest income would be expected to fall by $2.3 billion.
And the same is true, though to a lesser extent, if short- or long-term rates fall in isolation. If short-term rates were to fall by 50 basis points, while long-term rates stay the same, then Bank of America's net interest income would drop $1.1 billion. Conversely, if long-term rates decline but short-term rates stay steady, then the drop in net interest income would be $1.2 billion.
Which scenario is most likely?
It seems safer to assume that interest rates will trend higher rather than lower in the years ahead. I say that because, since the financial crisis, rates on both ends of the yield curve have been historically low, with short-term rates hovering near 0% for much of the past decade. For all intents and purposes, then, there's really only one direction that interest rates are likely to go: up.
In short, combined with the progress that Bank of America has made with its fundamental performance, the upward trajectory of interest rates is good news for the bank and its shareholders.