AAs the Federal Reserve prepares to raise its key overnight lending rate — the federal funds rate — for the first time since the pandemic began, banks are poised to take advantage.
Two of the banks that stand to benefit the most are Bank of America (NYSE: BAC) and Wells Fargo (NYSE: WFC), largely because both banks are large commercial lenders. Many commercial loans have variable interest rates that will increase with the federal funds rate.
With the Fed likely to raise rates at its March meeting, which major bank is likely to benefit more: Bank of America or Wells Fargo?
Asset Sensitivity Review
When banks make their quarterly and annual regulatory filings, they include an updated sensitivity table, which shows how certain rate hikes would impact banks’ net interest income (NII), which is generally the earnings that banks realize on their loans and securities after covering the cost of financing these assets. It is usually one of the main drivers of a bank’s revenue and profitability, although it can vary from bank to bank.
Bank of America and Wells Fargo are two of the largest commercial banks in the country and two of the most asset sensitive, which means that the returns on their assets such as loans reset with the federal funds rate are greater than their liabilities such than deposits.
In its recently released 10-K annual report, for the period ending December 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 rise, the Bank would reap another $7.1 billion from NII over the next 12 months.
Bank of America in its annual report revealed that in the same situation, the NII would increase by just over $6.5 billion.
I always find it strange for banks to do a sensitivity analysis like this, because it would be extremely rare for the Fed to raise its benchmark rate by one percentage point all at once. However, St. Louis Federal Reserve Chairman James Bullard recently asked the Fed to raise its key rate by a full point by July.
Economists at Citigroup a few weeks ago predicted that the Fed would raise the benchmark rate by half a percentage point in March (the Fed typically does this in 0.25% increments).
I find it interesting that Wells Fargo is more asset sensitive than Bank of America as of December 31 because, at the end of last June, the opposite was true. With an instantaneous full percentage point hike in the federal funds rate, Bank of America expected to make over $8 billion in NII over the next 12 months from that date. Wells Fargo was actually less asset sensitive than it is today, expecting to make only $7 billion at that time.
How to interpret this data
I would advise investors against following this data as a strict guide. As we have just seen in the second half of 2021, asset sensitivity can change rapidly and for a variety of reasons, including changes in a bank’s deposit base, securities deployment, and various hedging strategies.
Another thing to understand is that these scenarios don’t really take into account the impact of deposits being less rigid than expected and banks having to pay more interest on deposits as rates rise. This is harder to predict but can have a big impact on the NII because deposits fund the majority of the loans banks issue and the securities they buy, so if the cost of deposits goes up it lowers the NII. Investors are also aware of upcoming 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 well this year and with the bank also continuing decrease spending As part of its ongoing efficiency program, continued strong asset sensitivity is certainly an attractive aspect of Wells Fargo as rate hikes loom.
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Wells Fargo is an advertising partner of The Ascent, a Motley Fool company. Citigroup is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz owns Citigroup and has the following options: January 2024 long calls at $90 on Citigroup. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.
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