Bank investors should wait to reap the benefits of rising interest rates

JPMorgan Chase on Friday reported a record annual profit in 2021. But a combination of this, coupled with the release of set-aside for bad loans, driven by uncertainty about 2022, will see many investors seeing that remarkable result immediately. At present, it is putting some major pressure on the stock, which declined sharply on Friday morning. Investors shouldn’t miss out on the big picture.

On the face of it, the prospect of a series of Federal Reserve rate hikes should be a solid foundation for larger banks to generate higher lending income. There should also be a strong tailwind from US economic growth anticipated for this year, and consumers and businesses are unlikely to be relatively flush and produce waves of defaults.

But JPMorgan also details a number of challenges that could outweigh these positives in the coming year. At least in 2022, this could make it difficult to meet the bank’s medium-term target of 17% return on tangible common equity.

For one, consumers still aren’t rolling around on their cards as much as they have historically. Lower borrowing can offset the benefits of higher rates. JPMorgan said that, although spending volume was above pre-pandemic levels, outstanding card balances in the fourth quarter were down 8% from the same period in 2019. Growth has accelerated since mid-2021; But, broadly speaking, the bank is still not expecting the revolving balances on the cards to return to pre-pandemic levels by the end of this year.

Then there’s the other side of the high rate coin: inflation. Inflationary pressure on expenses—in compensation, travel-and-entertainment expenses and other areas—could decelerate the return on tangible common equity by about 0.75 percentage points in 2022, the bank underlined. Over time, the hope is that higher rates will outweigh the impact of higher costs — if those increases are modest.

None of this is to say that higher rates are still not fundamentally good for banks, especially if the curve is sharp. JPMorgan continues its bet on rates, saying it has been cautious about buying long-term assets when it adds to its securities portfolio, which will lock in at current rates. Chief Executive Jamie Dimon believes there is a good chance the Fed could act on rates more aggressively than markets expect. This gives the bank a great opportunity to deploy its huge liquidity when rates are high.

In addition, a volatile rate environment could help Wall Street’s revenues stay elevated for a while. Fixed-income trading desks can be particularly busy handling trades if there is a surprise in the pace of rate increases. Another strong year in the markets and investment banking will bring in substantial gains for returns.

So perhaps investors looking forward to 2022 should not expect banks to respond positively to every indicator of higher rates. But they should also not leave them for long.