One thing that would really help banks right now are higher interest rates. But just how much they'd help depends on the bank.
Continue Reading Below
In Wells Fargo's (NYSE: WFC) case, a 100-basis-point increase in both short- and long-term rates would bolster its net interest income by between 2% and 5% over the 12 months following the increase. Given that the California-based bank generated $47.8 billion in net interest income last year, that equates to a benefit of between $1 billion and $2.4 billion in added revenue.
Image source: The Motley Fool.
The extra revenue would be a welcome relief for Wells Fargo. It has now recorded two consecutive years of falling earnings, a rarity for the once highly regarded bank. AndWells Fargo's fake-account scandal, revealed by the Consumer Financial Protection Bureau last September, has only made things worse.
Higher legal expenses combined with lower revenue from cross-selling -- Wells Fargo eliminated product sales goals in its branches in response to the scandal -- has caused itsefficiency ratio to climb from 58.7% in the first quarter of last year up to 62.7% in the first quarter of this year. This means operating expenses are eating up an additional 4 percentage points' worth of revenue today compared to this time in 2016.
The impact of higher rates isn't exclusively positive for Wells Fargo. While they will boost the amount of money it earns from its $1.8 trillion portfolio of earnings assets, Wells Fargo's cost of funds would go up as well. The latter is tied to the interest rate paid on deposits, as well as the rate a bank pays to borrow from institutional investors, both of which should roughly track the trend in theFederal funds rate, the principle short-term interest rate benchmark in the United States.
Continue Reading Below
Image source: Getty Images.
To this end, Wells Fargo estimates that a 100 basis point increase in short- and long-term rates will boost the yield on its earning assets by 50 to 60 basis points, or 0.50 to 0.60 percentage points. The same scenario will cause its cost of funds to climb 40 to 50 basis points, according to the bank's asset sensitivity analysis.
The net result is that Wells Fargo expects its net interest margin, which captures the difference between a bank's yield on earning assets and its cost of funds, to climb by 5 to 15 basis points under this scenario.
It's unlikely the Federal Reserve will in fact raise rates by 100 basis points this year, as its dot plot shows that the central bank expects to raise rates only two more times this year, for a total of 75 basis points, including the March rate hike. But even this would be positive news for Wells Fargo and other banks, which stand to benefit from any increase in rates, however large or small it turns out to be.
10 stocks we like better than Wells Fargo
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now...and Wells Fargo wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of May 1, 2017.