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The Perfect Storm For Homebuyers
Interest rates are on the rise. And that spells trouble for homebuyers.
As we point out in our main story, higher interest rates benefit banks through higher net interest income.
But that’s not the entire story.
Not all banks are created equal.
Some thrive in an environment of rising interest rates. Others not so much.
For example, JPMorgan Chase (JPM) and Wells Fargo (WFC) are among banks with the largest exposure to mortgages. The two banks derive 41% and 47% of their revenue via consumer banking and lending, respectively.
Home lending accounts for more than 20% of Wells’ revenue in this segment.
Here’s a snapshot of Wells’ mortgage activity, as of Q4/2021. Due to cost-cutting measures, such as branch closures and layoffs, it has already started to decline.
Source: Wells Fargo Investor Relations
Why would this be a problem with home prices through the roof?
Supply and demand.
Thanks, in part, to short supply, both condo and single-family home buyers face stiff and increasing competition.
But it’s more than that.
When homes go above the asking price, it means that those pre-approved loan amounts may not be enough, with cash buyers carrying a distinct advantage.
And rates keep rising, with the 30-year eclipsing 4.75% this week.
An ugly picture for home buyers, with no comfort or concrete solutions in sight.
How does this hurt banks?
Those with heavy loan activity tied to mortgages will see lower activity on their non-interest income. AKA mortgage fees in the consumer sector.
So, before you drop cash into the nearest banking stock, take a look at their financials to see which ones have more exposure to mortgages as a percentage of total revenue.
Look To Banks, But Not For A Mortgage
To illustrate the opportunity investors can seize with banks amid rising interest rates, we’ll consider Bank of America (BAC).
The Fed has indicated it will increase interest rates six times throughout 2022. This is good news for banks, as illustrated by the following data via Bank of America Investor Relations.
As deposits increase, Bank of America makes more money.
This is because its Net Interest Margin will increase leading to an increase in net interest income.
Net Interest Margin is the difference between how much income banks generate from loans and the interest they pay out on deposits.
They tend to pay borrowers based on short-term interest rates and lend at longer-term interest rates.
Keep in mind, banks only need to hold a fraction of the total deposits necessary to cover the loans (known as fractional banking). That’s why deposit growth is so important for banks.
Bank of America addressed this on its most recent earnings call, which came prior to the aforementioned news from the Fed. The company noted that its Net Interest Income is already above the level it was at during the middle of the Fed’s last rate hike cycle.
As long as loan deposits continue to grow and the Fed sticks to its plan, Bank of America should continue to perform well on this metric.
Meanwhile, JPMorgan Chase expects net interest income to increase by $5.5 billion in 2022 compared to last year. Wells Fargo anticipates a roughly 8% year-over-year pop in its net interest income.
Again, these projections hinge on the Fed acting as expected and other factors, such as ordinary deposit account holders keeping their money at these big banks instead of moving it as yields become more attractive elsewhere.
However, the Fed recently signaled its intentions to raise rates faster earlier. That pulls forward more potential profits for banks
Bottom line: From a consumer standpoint, the price of just about everything – from gas to housing – paints a bearish picture. However, there’s always opportunity for investors, particularly long-term investors.
Banks such as BAC, JPM, and WFC stand to benefit from an environment of rising interest rates, which looks to persist through 2022. Given their larger exposure to mortgages, JPM and WFC don’t look quite as attractive as BAC in this context.
If you want to invest in broader baskets of financials, consider the XLF financial ETF or the KRE Regional Bank ETF.
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