As the Federal Reserve gears up to raise its benchmark overnight lending rate -- the federal funds rate -- for the first time since the pandemic started, banks are poised to benefit.
Two of the banks expected to profit the most are Bank of America (BAC 3.35%) and Wells Fargo (WFC 2.74%), largely because both banks are heavy commercial lenders. Many commercial loans have variable interest rates that will move higher along with the federal funds rate.
With the Fed likely to raise rates at its March meeting, which big bank is likely to benefit more: Bank of America or Wells Fargo?
Image source: Getty Images.
Looking at asset sensitivity
When banks make their quarterly and annual regulatory filings, they include an updated sensitivity chart, which shows how certain rate hikes would impact the banks' net interest income (NII), which is typically the profits that banks make on their loans and securities after they cover the cost of funding those assets. It's usually one of the largest drivers of revenue and profitability at a bank, although it can vary depending on the bank.
Bank of America and Wells Fargo are two of the largest commercial banks in the country and two of the most asset-sensitive, meaning more of the yields on their assets such as loans reprice with the federal funds rate than do their liabilities such as deposits.
In its recently released annual 10-K report, for the period ending Dec. 31, 2021, Wells Fargo said that if the Fed instantly raised its benchmark lending rate by 1% and longer-term rates followed suit in a parallel shift up, the bank would reap an additional $7.1 billion of NII over the next 12 months.
Bank of America in its annual report disclosed that in the same situation, NII would rise a little more than $6.5 billion.
I always find it odd that banks do the sensitivity analysis like this because it would be incredibly rare for the Fed to hike its benchmark rate a whole percentage point all at once. However, St. Louis Federal Reserve President James Bullard has recently called on the Fed to raise its benchmark rate by a full point by July.
Economists at Citigroup a few weeks ago projected the Fed would raise the benchmark rate by half a percentage point in March (the Fed usually goes in 0.25% increments).
I find it interesting that Wells Fargo was more asset-sensitive than Bank of America as of Dec. 31 because, at the end of last June, the opposite was true. With a full percentage point instant rise in the federal funds rate, Bank of America expected to realize more than $8 billion of NII over the next 12 months from that time. Wells Fargo was actually less asset-sensitive than it is now, only expecting to realize $7 billion at that point in time.
How to interpret this data
I would caution investors from following this data as a strict guide. As we just saw in the back half of 2021, asset sensitivity can change quickly and for a variety of reasons, including how a bank's deposit base develops, securities deployment, and various hedging strategies.
Another thing to understand is that these scenarios do not really factor in the impact of deposits being less sticky than anticipated and banks having to pay more interest on deposits as rates rise. This is harder to predict but can have a big impact on NII because deposits fund the majority of the loans banks originate and the securities they purchase, so if the cost of deposits rises, that cuts into NII. Investors also know about coming rate hikes before they happen, so some of the benefits are likely priced into bank stocks.
That said, with Wells Fargo's NII expected to rise nicely this year and with the bank also continuing to cut expenses as part of its ongoing efficiency program, the continued strong asset sensitivity is certainly an attractive aspect about Wells Fargo as rate hikes loom.
