Bank of America leads commercial banking’s return to prominence

Earnings season for financial stocks has begun and the biggest names on the street are showing the markets what’s going on behind the scenes.

Bank stocks are typically the first to lead an economic cycle, and for the United States, the cycle appears to have bottomed out last month. However, business is only one driver, as a strong consumer is also needed to push the economy in the right direction. This is where Bank of America Co NYSE:BAC the results come in handy.

BAC shares fell 2%, but were likely dragged down by the rest of the market, which is down 4% over the past month. Investors wondering where the stock market is going care more about the trends revealed in the bank’s press release than the stock’s reaction to the market. Therefore, retail investors may take Bank of America’s results this week with a grain of salt. Luckily, Citigroup Inc. NYSE:C also reported its earnings last week, giving investors a more defined trend in the sector.

Where are interest rates going?

Net interest income (NII) is the bread and butter of these commercial banks. As deposits increase at any bank, the bank can, in turn, lend these deposits to other customers in products such as credit cards and mortgages. Of course, a high interest rate environment, like the one we find ourselves in today, is music to the ears of the lending department.

This is the case for Bank of America, as the bank’s net deposits increased 1.2% over last quarter to a total of $1.9 trillion.

The Federal Reserve (Fed) is delaying interest rate cuts, which are now priced in for September 2024 according to the CME’s FedWatch tool, meaning the bank can expect another quarter of higher NII on its largest deposits. However, management said NII will likely reach a “low point” for the year in the second quarter of 2024.

After hitting bottom, things are expected to return to normal, likely due to lower interest rates increasing the volume of credit cards and mortgages rather than the interest rate originated on those loans. This leaves investors wondering whether rates will rise or fall in the coming months.

Well, it’s a two-way bet for Bank of America. Investment banking activity delivered a 35% increase in fees, driven by equity and debt underwriting. As companies engage in deals based on bullish expectations and a positive financial outlook, this could mean we are nearing the end of a period of high interest rates.

The way things are going, the bank is trying to squeeze in one last run at high NII, and then focus on volume for low interest rates.

Bank of America’s bet on consumers

Just like Citigroup, which allows consumers with FICO scores below 660 to open multiple accounts, Bank of America is also showing confidence in US consumers. Although net charge-offs rose to $1.5 billion, compared to just $1.2 billion last quarter and $8.7 million a year ago, the bank opened more than one million accounts with credit cards in the quarter.

However, Bank of America changed its strategy on FICO scores, reporting a net increase across all lending products. Consumers’ FICO scores for credit cards, auto loans and mortgages all increased by an average of three points. Of course, this is a question of risk management, as default rates have risen to five-year highs.

Citigroup’s loan portfolios showed a similar trend with an increase in delinquencies and write-offs. As the two largest commercial banks provide the Fed with another worrying point, the bailout (through lower interest rates) may be imminent.

Insight into the stock market

Sales and trading produced the highest quarterly revenue in a decade, representing eight consecutive quarters of revenue growth. The two main products for this department are stocks (stocks) and fixed income (bonds). Revenue from bond trading was $3.3 billion for the quarter, while revenue from stock trading was just $1.9 billion.

Knowing that bond prices move in the opposite direction to their yields (interest rates), traders may have loaded up on bonds before the cuts arrived. Investors can understand this trend by seeing how iShares 20+ year Treasury bond ETF NASDAQ: TLT it recently reached its lowest price in 12 years. If and when the Fed cuts interest rates, Bank of America’s bond holdings, which rose by $40 million during the quarter, could likely boost the stock’s book value per share.

Overall it was an excellent quarter for the bank. More importantly, investors now know that interest rate cuts could be around the corner to help inflation-choked consumers.

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