After years of waiting, Bank of America Corp (BAC) stock investors finally got the news they had been hoping for in December: the Federal Reserve announced the highly anticipated first interest rate hike of the new tightening cycle! Everyone knows that higher interest rates pave the way for more profits and higher stock prices for banks…
Right?
As it turns out, since the rate hike was announced on December 16, the S&P 500 has lost 6%, while BAC stock has plunged 24%. What the heck is going on with the stock and where is the big interest rate bump that Bank of America stock owners were expecting?
Banks’ Core Business
To answer this question, we first have to look to why interest rates matter to BAC — and banks as a whole.
The core banking business is based on taking deposits and making loans. The key metric in assessing the profitability of this business is called net interest margin (NIM). NIM is calculated by subtracting the interest a bank pays on its deposits and debt from the interest it earns on its loans and securities. The result is then divided by the total value of the loans and securities to yield NIM.
Clearly, BAC stock owners want to see a high NIM. The higher the NIM, the more profitable a bank’s core business is, and the higher interest rates are, the more wiggle room banks typically have when it comes to NIM. A typical NIM for a bank in the 3% to 4% range, but the higher the better.
Here’s a look at the average NIM for all U.S. banks over the past decade, according to BankRegData.com.
As you can see, NIMs peaked at 3.84% in Q1 of 2010, but declined to new 10-year lows by Q1 of 2015. Q4 numbers showed some promise, however, with NIMs jumping back up to 3.35%.
Turning to BAC stock, the next graph comes…
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