How Will Higher Rates Help JPMorgan Chase?

By John

JPMorgan Chase (NYSE: JPM) has transformed into a powerful bank, and not just defensively, as can be assumed from CEO Jamie Dimon's obsession with a fortress balance sheet. Its offensive strength is equally strong, it just hasn't shown through as much because interest rates have been so low.

Continue Reading Below

The good news is that this could be about to change, with the Federal Reserve telescoping that it could raise rates multiple times this year. You can gather this from its latest dot plot, which shows that a plurality of members on its monetary policy committee believe its short-term interest rate benchmark should end the year between 1.25% and 1.5%.

That benchmark, the Fed funds rate, which is how much banks charge to lend each other excess reserves on an overnight basis, is currently between 0.5% and 0.75%. That implies three hikes of 25 basis points each if the Fed continues its gradual rate of increase.

For JPMorgan Chase, this would mean billions more in net interest income, which is high-margin revenue that largely falls to the bottom line. According to its recently filed 10-K, a 100 basis point increase in short- and long-term rates will translate into $2.4 billion worth of added net interest income. If rates go up twice that amount, JPMorgan Chase would earn $4 billion in extra net interest income.

More From

Data source: JPMorgan Chase's 2016 10-K, page 122.

It's worth pointing out that this is a fraction of JPMorgan Chase's annual net income. Last year, it earned $24.7 billion. Even if rates were to spike by a full 100 basis points, it would still increase JPMorgan Chase's bottom line by less than 10%. But if rates continue to head higher for multiple years, which could happen given where they are today, you could easily get the same boost to earnings for several consecutive years.

These interest rate increases will add up for a bank like JPMorgan Chase. They'll help to reveal what a powerful franchise the bank built as a result of the financial crisis. It acquired Bear Stearns in March 2008 for pennies on the dollar, gaining control over Bear's lucrative primary brokerage business. Six months later, JPMorgan Chase bought Washington Mutual for $1.9 billion in exchange for $180 billion worth of Washington Mutual's deposits and $176 billion of its home loans.

What will higher interest rates do for JPMorgan Chase? Image source: Getty Images.

These acquisitions, both done at bargain-basement prices, added considerable heft to JPMorgan Chase's product lineup and helped the bank climb to the very top of the heap not only as a Wall Street bank, but also as a Main Street bank. But their value won't be obvious until rates rise and lending margins widen; that's when the $180 billion worth of additional cheap deposits become valuable.

In short, while JPMorgan Chase could earn $2 billion or more in added net interest income this year, which will boost its bottom line, it's the prospect of more rate hikes in the future that makes this bank stock so attractive as a long-term hold.

10 stocks we like better than JPMorgan ChaseWhen 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 JPMorgan Chase 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 February 6, 2017.

John Maxfield has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.