With the Federal Reserve slated to raise its benchmark overnight lending rate (the federal funds rate) for the first time since the pandemic at its upcoming March meeting, most banks are expected to benefit. JPMorgan Chase (JPM 0.15%), America's largest bank, is no exception. The bank has tons of loans in its commercial and credit card portfolios that will see yields rise along with the federal funds rate. The bank has also been improving its deposit base.
But investors may not see the benefits of rising rates so clearly in JPMorgan's top line in 2022. Here's why.
Image source: Getty Images.
Different components of net interest income
The main benefit banks see from rising rates is in relation to their net interest income (NII), which is essentially the interest that banks make on loans, securities, and other assets after covering the cost of funding those assets. And most banks are asset sensitive, meaning that more of the yields on their assets reprice upward with the federal funds rates than yields on their liabilities, such as deposits. So if more yields on their assets rise than on their deposits and other funding sources, the bank will widen its margins and make more money.
JPMorgan expects this to play out in 2022. However, there are different components of NII: There's the NII the bank makes on loans and securities, which I'll refer to as core NII, and then NII from JPMorgan's corporate and investment banking division, which I'll refer to as markets NII. JPMorgan generates the majority of its markets NII from its fixed-income trading division within the investment bank. The bank can make NII on bonds it holds, as well as the bid-ask spread from buying and selling the bonds. The fixed-income unit also does various types of financing and lending that generate NII.
Between 2019 and 2021, when rates fell to practically zero, JPMorgan saw its overall NII fall from $57.8 billion to $52.7 billion. But inside that number, core NII fell by more than $10 billion, while markets NII actually rose from $3.1 billion to $8.2 billion. Core NII suffered due to slumping loan growth and low interest rates, while markets NII, which contains quite a bit of complex factors that can swing it fairly significantly, flourished in the low-rate environment with a lower cost of funding and more activity in the division.
Image source: JPMorgan Chase Q4 investor presentation.
How core NII and markets NII will trend
As you can see in the chart above, JPMorgan expects core NII to jump back to close to $50 billion in 2022 when you factor in higher rates and loan growth, which the bank expects to be in the high-single-digit percentage range. However, the bank is not guiding for markets NII, making it difficult to know if it expects NII on a net basis to grow in 2022.
Higher interest rates can push up the funding costs in the fixed-income markets division, compressing NII. JPMorgan's CFO Jeremy Barnum also explained on the bank's most recent earnings call that there can be a lot of noise in markets NII from "irrelevant places, like interest rate hikes in Brazil and cash versus futures positions," which is why the bank doesn't like to overly rely on this NII. However, Barnum has also said in the past that most fluctuation in markets NII, whether up or down, tend to be offset in non-interest revenue, so it is difficult to quantify the overall impact of markets NII movement.
But it's pretty clear that markets NII seems to do better with lower interest rates and perform worse with higher interest rates. When interest rates were higher in 2019, markets NII made up a much smaller portion of total NII. But in 2020 and 2021 during the ultra-low-rate environment, markets NII generated $8.4 billion of NII and $8.2 billion of NII, respectively. Between 2017 and 2019, which was more of a rising rate environment, markets NII ranged from roughly $3.1 billion to $4.6 billion.
So given these historical numbers, JPMorgan could still top the $52.7 billion of NII it generated in 2021, but it might not end up being as large of a bump as investors might have expected from the rising rates.
An interesting dynamic at the bank
To sum it all up, JPMorgan will benefit from rising rates, with management anticipating an additional $5.5 billion of core NII. However, some of this rise could be offset by declining markets NII, creating less of a benefit on a net-net basis. Barnum has said the fluctuations in markets NII are offset in non-interest revenue, but that's a bit broader of a category, and investors follow the NII number much more closely. This slightly complex dynamic is something investors should keep in mind as they build their expectations for JPMorgan this year.
