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Why This Bank Could Rally 20%

Talking Numbers

Despite higher interest rates affecting balance sheet assets, one analyst believes Bank of America is a buy.

Some people believe that when interest rates move up, banks would benefit from it. After all, it gives lending institutions a reason to charge customers more for their loans and mortgages.

However, a story in today’s Financial Times suggests that bank balance sheets may actually be hurt with higher interest rates because they hold so many government bonds and mortgage-backed securities (MBS’s). One of those singled out is Bank of America. It has $315 billion in “available for sale” securities and, according to the FT, 90% of those are in US Treasuries and mortgage-backed securities.

First, a little background. There are three possible ways to classify financial securities on a balance sheet. Each one of these classifications affects shareholder equity and the income statement differently. They are:

  • Trading securities: As the name suggests, these are instruments purchased when a company is trading them on a short-term basis. Both realized and unrealized gains as well as interest and dividends are found on the income statement.
  • Available-for-sale securities: These are held longer than trading securities and may be sold as needed by the company. Interest, dividends, and realized gains end up on the income statement but unrealized gains and losses hit shareholders’ equity on the balance sheets.
  • Held-to-maturity securities: Again, the name says it all: These are bonds held on the books until they mature. Interest and realized gains go on the balance sheet. They are on the books at historic prices so there are no unrealized gains.

Even though a bank’s trading book may hold some bonds and mortgage-backed securities, banks also hold a lot of them as “available-for-sale” because they’re fairly liquid and can be better than cash because they earn interest. But, when interest rates go up, the value of fixed-income securities like bonds and MBS’s go down.

While interest rates on the 10-year Treasury bond have gone up above 2.5%, they are still lower than they were in 2011. Will the hit be huge for financial institutions like Bank of America?

We ask CNBC contributor Steve Cortes, Founder of Veracruz TJM, and Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson, to look at the fundamentals and technicals and decide if investing in Bank of America is as safe as money in the bank.

According to Ross, Bank of America’s charts show it can move much higher based on price action. On the fundamentals, Cortes believes there’s another industry affecting banking – housing.

What technical indicators does Cortes think will lift BoA’s stock higher? And, how does the housing market affect banks? Watch the video above to find out more.

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