WIf the US Federal Reserve plans to raise its federal funds rate benchmark at its upcoming March meeting for the first time since the pandemic, most banks should benefit. JPMorgan Chase (NYSE:JPM), America’s largest bank, is no exception. The bank has tons of loans in its business and credit card portfolios, yields on which will rise in tandem with the federal funds rate. The bank has also improved its deposit base.

But investors may not see the benefits of rising interest rates as clearly in JPMorgan’s 2022 sales. Here’s why.

Image source: Getty Images.

Different components of net interest income

The main benefit banks derive from rising interest rates is in terms of their net interest income (NII), which is essentially the interest banks earn on loans, securities and other assets after they bear the cost of funding them assets have covered. And most banks are asset sensitive, which means more returns on their assets are rated up by federal funds rates than returns on their liabilities, such as debt. B. Deposits. So if more returns on its assets increase than its deposits and other sources of funding, the bank will expand its margins and make more money.

JPMorgan expects that to happen in 2022. However, there are several components of NII: There is the NII that the bank does for loans and securities, which I will refer to as core NII, and then NII from JPMorgan’s corporate and investment banking division, which I will refer to as markets NII . JPMorgan generates the bulk of its market NII from its fixed income trading arm within the investment bank. The bank can make NII on bonds it holds and the bid-ask spread from buying and selling the bonds. The fixed income unit also conducts various types of financing and lending that generate NII.

Between 2019 and 2021, when interest rates fell to virtually zero, JPMorgan saw its total NII fall from $57.8 billion to $52.7 billion. But within that number, core NII fell more than $10 billion while market NII actually rose from $3.1 billion to $8.2 billion. Core NII suffered from collapsing credit growth and low interest rates, while Markets NII, which contains a number of complex factors that can affect it quite heavily, thrived in the low interest rate environment with lower funding costs and more activity in the market.

Image Source: JPMorgan Chase Q4 Investor Presentation.

How Core NII and Markets NII will develop

As you can see in the chart above, JPMorgan expects core NII to grow back to nearly $50 billion in 2022 if you factor in higher interest rates and credit growth, which the bank expects to be in the high single digits. However, the bank doesn’t provide guidance on the markets’ NII, making it difficult to know if it expects the NII to grow on a net basis in 2022.

Higher interest rates can drive up funding costs in the fixed income space and compress NII. JPMorgan CFO Jeremy Barnum also explained on the bank’s recent conference call that there can be a lot of noise in the NII markets from “irrelevant places like rate hikes in Brazil and cash versus futures positions,” which is why the bank doesn’t exit like to focus too much on this NII. However, Barnum has also said in the past that most fluctuations in markets’ NII, whether up or down, tend to be offset by noninterest income, making it difficult to quantify the overall impact of markets’ NII movement.

But it’s pretty clear that the NII markets do better when interest rates are lower and underperform when interest rates are higher. When interest rates were higher in 2019, the markets’ NII made up a much smaller portion of the total NII. But in 2020 and 2021, during the ultra-low interest rate environment, the NII markets generated $8.4 billion in NII and $8.2 billion in NII, respectively. Between 2017 and 2019, which was more of a rising interest rate environment, the markets’ NII ranged between approximately $3.1 billion and $4.6 billion.

So, given those historical numbers, JPMorgan could still surpass the $52.7 billion in NII it generated in 2021, but it might not end up being as big as investors were expecting given rising interest rates.

An interesting dynamic at the bank

In summary, JPMorgan stands to benefit from rising interest rates, with management anticipating an additional $5.5 billion in core NII. However, some of this increase could be offset by declining markets’ NII, resulting in a reduced advantage on a net-to-net basis. Barnum has said that fluctuations in the NII markets are offset by noninterest income, but that’s a slightly broader category and investors follow the NII number much more closely. Investors should keep these somewhat complex dynamics in mind as they build their expectations for JPMorgan this year.

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