OWith the Federal Reserve planning to raise its key overnight lending rate (the federal funds rate) for the first time since the pandemic at its next meeting in March, most banks stand to benefit. JPMorgan Chase (NYSE: JPM), the largest US bank, is no exception. The bank has tons of loans in its business and credit card portfolios that will see yields increase with the federal funds rate. The bank also improved its deposit base.
But investors may not see the benefits of higher rates in JPMorgan’s 2022 revenue so clearly. Here’s why.
Different components of net interest income
The main benefit banks derive from rising rates relates to their net interest income (NII), which is essentially the interest banks earn on loans, securities and other assets after covering the cost financing of these assets. And most banks are asset-sensitive, meaning more of the returns on their assets are repriced higher with federal funds rates than returns on their liabilities, such as deposits. So if the returns on their assets increase more than those on their deposits and other sources of funding, the bank will widen its margins and earn more money.
JPMorgan expects this to happen in 2022. However, there are different components of the NII: there is the NII that the bank gives on loans and securities, which I will call the base NII, then the NII of JPMorgan’s corporate and investment banking division, which I’ll call NII Markets. JPMorgan generates the majority of its NII markets from its fixed income trading division within the investment bank. The bank can do NII on the bonds it holds, as well as the bid-ask spread of buying and selling the bonds. The Fixed Income Unit also performs various types of financing and lending that generate NII.
Between 2019 and 2021, when rates fell to virtually zero, JPMorgan saw its overall NII drop from $57.8 billion to $52.7 billion. But within that figure, the base NII fell more than $10 billion, while the markets NII fell from $3.1 billion to $8.2 billion. The base NII suffered due to the collapse in loan growth and low interest rates, while the markets NII, which contains a number of complex factors that can swing it quite significantly, thrived in the low rate environment with a lower cost of funding and more activity in the division.
How will the base NII and NII markets evolve?
As you can see in the chart above, JPMorgan expects the base NII to return to nearly $50 billion in 2022 when you take into account rising rates and loan growth, whether the bank expects it to be in the single-digit percentage range. However, the bank does not guide NII markets, making it unclear whether it expects NII on a net basis to rise in 2022.
Higher interest rates can drive up funding costs in the fixed income markets division, compressing the NII. JPMorgan chief financial officer Jeremy Barnum also explained on the bank’s latest earnings call that there can be a lot of noise in NII markets from “irrelevant places, like interest rate hikes. interest in Brazil and cash positions versus futures”, which is why the bank does not. like to rely too much on this NII. However, Barnum has also said in the past that most movements in NII markets, whether up or down, tend to be offset by non-interest income, so it’s hard to quantify. the overall impact of the NII market movement.
But it’s pretty clear that NII markets seem to do better with lower interest rates and perform worse with higher interest rates. When interest rates were higher in 2019, the markets’ NII represented a much smaller share of the total NII. But in 2020 and 2021, in the ultra-low rate environment, NII markets generated $8.4 billion from NII and $8.2 billion from NII, respectively. Between 2017 and 2019, which was more of a rate hike environment, the markets’ NII ranged from around $3.1 billion to $4.6 billion.
So, given these historic numbers, JPMorgan could still surpass the $52.7 billion in NII it generated in 2021, but that might not be as big as investors might have expected from rising valuations. rate.
An interesting dynamic at the bank
In summary, JPMorgan will benefit from the rate hike, with management expecting an additional $5.5 billion in base NII. However, some of this rise could be offset by the markets lower NII, creating less benefit on a net-to-net basis. Barnum said fluctuations in NII markets are offset by non-interest income, 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 when building their expectations for JPMorgan this year.
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