Wednesday, March 6, 2013

JPM, BAC, WFC To Greatly Benefit from Future Prime Rates

With the prime rate currently at 3.25% many bank holding companies profits have been stretched due to low interest rate margins. On average the largest portion of revenue for banks comes from interest revenue. Because of our current low prime rate for an extended period of time many of the U.S. largest banks are lending less money measured by their deposits. Because banks are lending less money the economy is growing at a very slow rate. For the fourth quarter of 2012 the US economy grew at 0.1%

Although lending may not be the sole reason the economy is still struggling, more lending would certainly help. Because of the slow growth the Federal Reserve believes it is in the best interest of the U.S. economy to keep interest rates artificially low. However interest rates cannot and will not stay this low for long. As interest rates naturally begin to raise banks will see better interest rate margins and profits. While interest rates are still low and banks are lending less, now is the time to consider adjusting investments in your portfolio to take advantage of this upcoming opportunity.

J.P.Morgan and Chase (NYSE: JPM) is the largest bank in the U.S measured by assets. JPMorgan Chase Bank has bank branches in 23 different states with 5,100 different branches and over 16,000 ATMs. With the size of Chase Bank, J.P. Morgan has some form of financial relationship with nearly half of all U.S. households. It currently has the number one ATM network in the U.S. and number two branch network.

J.P. Morgan is the leading bank in mortgage origination, small business lending and auto lending based on the number of applications. With its strong standing in lending J.P. Morgan will benefit greatly with improved interest rate margins. In 2009 when most of its loan portfolio would have been written at higher prime rates J.P. Morgan chase had a net interest margin of 8.08%. For 2012 its net interest margin was 3.89% a decrease of 52%.

Bank of America (NYSE: BAC) is the second largest U.S. Bank measured by assets. It has locations in all 50 states, with over 5,600 branches and over 16,000 ATMs. Bank of America's retail network covers around 80% of the U.S. population. In 2009 its net interest rate margin was 5.00% and for 2012 it declined to 4.38% which is a 12.40% decrease. Although its margin did not shrink as much as J.P.Morgan the decline still hurts earnings.

With over 927 billion in loans on its balance sheet in 2012 a decrease of 35 billion from 2008 Bank of America will have more of an incentive to lend with improved profitability in lending. With deposits growing we should see a good correlation with lending growth not a negative correlation. Bank of America has more money to lend out so it should be lending more money out. One possible explanation is the bank does not feel it will be compensated enough with current interest rates to make up for the risk.

Wells Fargo (NYSE: WFC) is the fourth largest bank in the U.S. measured by assets with over 9,000 branches and over 12,000 ATMs. In 2009 Wells Fargo's net interest margin was 5.50% in 2009 and 5.16% in 2012 it had the smallest decrease of the three banks. It is the number one car lender, commercial real estate originator and small business lender in the U.S. Currently 55% of Wells Fargo's loan portfolio is retail and 40% is commercial.

From 2011 to 2012 Wells Fargo's total deposits grew 8% while its lending only grew 4%. This continues to show the disconnect from funds available to lend and actual lending. Although it has not had the same growth in lending as it has experienced in deposits, Wells Fargo is well positioned to capitalize on increased interest rate margins because of their market leading position.

Over the past five years the top five banks in the U.S. have decreased the percentage of deposits lent out. Of the five J.P.Morgan Chase had the lowest ratio only lending out 61% of its deposits. That combined with the fact it experienced the greatest decline in net interest margin over the past few years positions it to rebound the greatest as interest rates increase. J.P.Morgan Chase also has a strong market position leading certain lending categories it will be able to quickly adjust its deposit to loan ratio as management feels the profitability of more lending outweighs the risk.

If you are considering an investment in a bank to take advantage of improved interest rate margins as rates increase J.P.Morgan Chase will benefit the greatest.

(Net interest rate margin was calculated by net interest income / total loans.)

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