Wells Fargo & Co (WFC), Bank of America Corp (BAC): Book Value Erosion a Concern for These Banking Stocks

Page 1 of 2

Interest rates have been on the rise since the start of the current year. While rising interest rates usually mean higher income and the resultant wider net interest margin for the US banks, it also means a drop in the book value of the fixed income instruments held by these banks.

Let’s see which banks will be hurt the most and why.

Wells Fargo & Co (NYSE:WFC)

Rates on the rise despite QE

The third round of quantitative easing was mainly aimed at bringing long-term Treasury and mortgage rates down. However, despite the Fed’s commitment to continue its easing programs, rates have gone up since the start of the quarter. That’s because of speculations about the Fed’s exit. The speculation started in mid May and since then the markets have started pricing in the impact of the Fed’s exit.

As a result, the 10-year Treasury yield climbed 66 basis points (bps), while 30-year fixed mortgage rates jumped 89 bps since the start of the current year. While the rise in rates theoretically means higher net interest margins for banks, they also mean book value erosion. However, both the positive and negative impacts of rising interest rates are different for banks.

Let’s see which factors lead to higher book value declines in some banks rather than others.

Fixed income portfolio duration

Banks are thought to possess large portfolios of fixed income instruments which yield interest income. However, with the rise in rates, the value of these fixed income portfolios declines. The decline in their value is dependent on the duration of the fixed income portfolio. For those who are not familiar with the term duration, it measures the sensitivity of change in the portfolio value to move in the interest rates.

Credit Suisse provides estimates of the large cap banks’ durations. According to those estimates, Wells Fargo & Co (NYSE:WFC), PNC Financial Services (NYSE:PNC) and Bank of America Corp (NYSE:BAC) have the highest estimated durations of 3.5 years, 2.3 years and 2.3 years, respectively.

Wells Fargo & Co (NYSE:WFC)Credit: Wells Fargo & Co (NYSE:WFC)

Book value sensitivity

This high duration of the fixed income portfolios at the aforementioned banks leads to a more book value that is more sensitive to rising interest rates.

A 100 bps increase in the interest rates will bring about a 0.4% decline in Wells Fargo & Co (NYSE:WFC)’s tangible common equity, while declines for PNC Financial Services (NYSE:PNC) and Bank of America Corp (NYSE:BAC) are 0.26% and 0.21%, respectively. Similarly, if we talk about the banks’ tangible book values, Wells Fargo will experience around 4.5% decline in  book value, followed by 3% at Bank of America and 2.9% at PNC Financial.

Credit Suisse estimates that Wells Fargo & Co (NYSE:WFC)’s book value has plunged 0.2% since the start of the second quarter, compared to a 0.3% plunge in Bank of America Corp (NYSE:BAC)’s book value. Besides, Citigroup has experienced around 0.7% decline in its book value over the same time period.

Impact on interest income

While Wells Fargo & Co (NYSE:WFC)’s book value might be hit the most from increasing interest rates, its top executives have made it clear that the bank’s interest income will experience some expansion. Bloomberg reported the bank’s CFO saying that Wells Fargo is well positioned to benefit from rising interest rates. The bank is considered not to be stuck with loans and securities which lose value as the interest rates go higher.

Page 1 of 2
Comments
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months. Our beta is only 1.2 (don't click this link if beating the market isn't important to you).

Lists

Foods That Stain Your Teeth

Richest Doctors in the World

The Best Movie Sountracks Ever

The Highest Grossing Musicals on Broadway

The Most Successful Reality TV Stars

Cheapest Cities to Visit in the US

Most Expensive Summer Camps

Most Expensive Animals in the World

Most Expensive Specialty Crops in the World

Movies That Took Ages to Make

The Longest Hollywood Films Ever Made

Most Expensive Concert Stages

The Richest Bands of all Time

10 Most Corrupt Countries 2013 List

10 Countries with the Highest Quality of Life Index

Most Expensive Mattresses in the World

5 Smallest Countries by Land Area

The Ultimate Heartbreak Songs

Richest Teenagers in the World

10 Most Haunted Places in America

10 Best Places to Retire in Florida East Coast

Top 10 Places to See Before You Die

Top 8 Countries in the World Where Justice Prevails

10 Richest States in America

15 Wealthiest Countries in the World

Richest Singers in the World

Most Expensive Tasting Menu in New York City

Most Expensive Baby Items in the World

Most Expensive Hotel Suites in Vegas

Most Expensive Brunch in New York City

Most Expensive Beef Cuts in the World

25 Best Colleges to Get a Job

Top 10 US Supermarkets

The 25 Most Dangerous Cities in the World to Visit

Most Expensive Xbox Games

Top 11 Cities Where Billionaires Live

Top 10 Most Charitable Companies in America

Most Expensive Seafood in the World

The 10 Wildest Conspiracy Theories

The 10 Best Job Markets in the US

Top 10 Accounting Scandals of All Time

The 25 Biggest Cities in the World

Top 10 Best Paying Virtual Jobs

Most Expensive Leather Shoes in the World

Top 6 Things to Buy in March

The 10 Most Stressful Jobs in America – 2014 List

Top 10 Jobs for Introverted People

Top 10 Honeymoon Destinations in the World

Top 10 Highest Paying Jobs in the World

Most Expensive Day-Care in New York City

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!