For the first time in more than four years, the Federal Reserve has lowered the target range for its benchmark federal funds rate, announcing a half-point rate cut on Wednesday. Lower interest rates can serve as a shot of adrenaline for stocks, because lower treasury yields make riskier assets more appealing.
Banks and other financial companies should benefit too, as long as there isn't a severe recession. Here's one bank stock to buy.
A potential boost to earnings
While banks have been known to perform well when rates are rising, the yield curve is more important. For the past two years, the yield curve has been inverted, which means longer-dated Treasury bills have yielded less than shorter-dated ones. Now, the yield curve is steepening, which is good for the sector because banks generally borrow short and lend long. One bank that should benefit is JPMorgan Chase(NYSE: JPM), the largest bank in the U.S. by assets.
Now, this might not happen right away. At a recent industry conference, JPMorgan Chase's chief operating officer, Daniel Pinto, said he thought consensus estimates for net interest income (NII) in 2025 were too high. NII is essentially the difference between what banks make on interest-earning assets, such as loans, and pay out on interest-bearing liabilities, such as deposits. Pinto specifically cited the potential drop in interest rates as the reason why consensus was likely too high. JPMorgan is asset-sensitive, and therefore NII, a key source of revenue, benefits from rising rates. Over time, the steep yield curve will benefit the bank. But deposits reprice on a lag, so the company won't benefit from lower deposit pricing right away.
However, NII could also benefit from loan growth, which is not being priced in yet. According to consensus estimates provided by Visible Alpha, average loan balances, which are a big part of the NII calculation, are only projected to grow roughly 3.25% in 2025. That would be JPMorgan's slowest loan growth by far in four years. Management has lamented on earnings calls how loan growth has been muted.
Businesses, concerned about the macro outlook, have been waiting for rates to fall. A different large bank has been pointing out on earnings calls that capital expenditures as a percentage of revenue, as well as inventory growth rates, have been below historical averages. This is usually a leading indicator of commercial loan growth. Now, with some more clarity in the rate outlook, businesses may now be more prone to draw on their lines of credit and invest.
The other beautiful thing about JPMorgan is that it runs several strong banking businesses that can help balance one another. JPMorgan's investment banking division is one of the strongest in the world, and mergers and acquisitions (M&A) and initial public offerings (IPOs) have been down in the high-interest-rate environment. While these revenues are very difficult to forecast, lower interest rates should boost activity and lead to a pickup in revenue moving forward.
Lower interest rates should also help with credit and take some pressure off of consumers who were feeling the pinch from higher prices, as well as loans on commercial properties that may have been dealing with higher costs associated with insurance or building materials. Credit has held up well at JPMorgan, but lower rates will bring relief in regards to where delinquencies and loan loss rates could have gone in the future had interest rates stayed higher for longer.
Finally, while never a big problem for JPMorgan, the bank does have unrealized paper losses from things like underwater securities. Those will be recouped over time -- and on a faster basis -- as interest rates fall. I estimate that the unrealized securities losses at the end of the second quarter equate to nearly $4 of lost book value, which is what banks trade relative to.
Long-term benefits from falling interest rates
While there could be some near-term headwinds to NII, JPMorgan will benefit from falling interest rates and the steepening of the yield curve in the long term. They should reignite loan growth and eventually allow the bank to reprice deposits lower. Additionally, lower interest rates could reignite M&A and IPO activity, which would help investment banking. They also should provide relief to consumers and businesses and prevent loan loss rates from creeping too high. Finally, lower rates will help JPMorgan recoup lost book value.
All of this is good for the stock, which I continue to view as a good long-term buy.
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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends JPMorgan Chase. The Motley Fool has a disclosure policy.
