As Interest Rates Rise, which Bank Can Outperform?

The U.S. Fed recently announced a 0.5% increase in benchmark interest rates to bring sky-high inflation down. The Fed’s policy response to tame inflation through interest rate hikes is a positive signal for banks. Notably, the rising interest rate environment supports banks’ net interest income (NII). 

However, the market’s response has been cold, as an increase in interest rates have failed to lift bank stocks. Moreover, shares of several top banks are trading in the red on a year-to-date basis. 

For context, JPMorgan Chase, Bank of America, and Wells Fargo shares are down about 22%, 18%, and 7%, respectively, on a year-to-date basis.

Given the higher interest rates, the NII of banks is expected to expand in the coming quarters. However, the Fed’s aggressive stance could lead to a slowdown in the economy. Moreover, the ongoing geopolitical conflict and the pandemic in the background continue to play spoilsport. 

Against this backdrop, let’s look at the recent performance of top banks, revisit management commentary, and focus on analysts’ recommendations to ascertain what the future holds. 

Bank of America (NYSE:BAC)  

Bank of America delivered better-than-expected Q1 financials. Further, during the Q1 conference call CEO Brian Moynihan, stated that higher interest rates and loan growth would significantly improve NII in the next several quarters. A higher NII and focus on expense management will likely cushion margins. 

However, he added that interest rate hikes amid a highly inflationary environment could slow the economy. Nevertheless, Bank of America’s solid asset quality, higher NII projection, and operating leverage augur well for growth. 

Bank of America stock sports a Moderate Buy consensus rating on TipRanks based on seven Buy and six Hold recommendations. Further, the average Bank of America price target of $46.67 implies 28.3% upside potential to current levels.

Wells Fargo (NYSE:WFC)

Wells Fargo benefitted from continued economic recovery, and broad-based loan growth. Moreover, it doubled the full-year NII growth outlook (from 8% to a mid-teens rate) on higher interest rates and loan growth.

However, a slowdown in the refinance market could impact its mortgage business. 

Wall Street analysts are bullish on WFC stock, given the upbeat NII guidance and higher rates. Its Strong Buy consensus rating is based on nine Buy and three Hold recommendations. 

Further, the average Wells Fargo price target of $59 implies 34.2% upside potential to current levels.

JPMorgan Chase & Co. (NYSE:JPM)

JPMorgan missed analysts’ Q1 earnings estimates. However, the firm-wide loans and deposits improved. Also, it reiterated its NII outlook. It expects NII (excluding markets) to be over $53 billion in 2022, driven by higher loans and interest rates. 

However, the firm highlighted increased challenges ahead stemming from the ongoing supply chain issues, inflation, and Russia/Ukraine war. 

JPM stock has a Moderate Buy consensus rating on TipRanks based on 10 Buy, five Hold, and two Sell recommendations. Further, the average JPMorgan price target of $160 implies 31.3% upside potential to current levels.

Bottom Line

Higher interest rates and continued loan growth could drive the NII of banks in 2022. However, fee income coming from mortgage, wealth management, and service charges could take a hit due to lower refinance volumes, and a decline in the stock market. Further, inflationary cost pressure will likely drive the expenses of the banks. 

Baird analyst David George stated, “We look for core NII to grow sequentially over the next several quarters, driven by positive loan growth trends, deployment of excess liquidity into higher yielding loans/securities, and Fed tightening.” 

However, he expects fee trends to remain soft due to moderation in the capital and mortgage market. Also, the analyst expects costs to trend higher. 

Stock-wise, George remains sidelined on BAC. He stated that with BAC stock “trading at ~1.85x TBV, we don’t find it inexpensive enough for fresh money here but feel there isn’t a great short case either.” 

As for JPM stock, he recommends a Hold. George added, “Overall, JPM’s diversified franchise, superior PPNR returns, and longer-term investments should position the company well for the future. While we appreciate JPM taking the long view, risk/reward seems balanced, and we wouldn’t chase the stock at ~1.85x TBV.”

The analyst is bullish on WFC stock, as he believes that it is undervalued “based on long-term EPS power.” He added that “WFC continues to trade at a discount to peers at ~1.3x TBV and it’s one of the only reasonable mega-cap names on a valuation basis.” 

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Read full Disclaimer & Disclosure

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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