Bank of America Should Outperform On Core Growth In ’25-’26, But Is That Priced In?

Summary:

• Bank of America has continued to outperform smaller, more spread-dependent banks, and Q2’24 should be the low point for NIM and net interest income.
• Leveraging past investments into technology, Bank of America should be able to pair slightly above-average revenue growth with above-average operating leverage, driving high single-digit pre-provision growth in ’25-’26.
• Bank of America has opportunities to leverage growth in trading and investment banking that may not be fully appreciated, as well as core consumer growth opportunities in wealth and cards.
• Core earnings growth of around 4% and mid-teens ROTCE can support a fair value in the low-to-mid-$40’s, suggesting that Bank of America shares are priced about where they should be.

The last 18 months have seen large “money center” banks continue to outperform smaller regional banks, as these larger banks can generally rely on more stable, lower cost funding, large sources of non-interest income, and flights to quality among more nervous customers. To that end, Bank of America (NYSE:BAC) has continued to perform since my last update, with an 18% move outdoing not only smaller regional banks but also large banks as well (though not quite as good as others like JPMorgan (JPM)).

At this point in the cycle, though, I’ve cooled some on Bank of America. This isn’t because of any flaw in this business, but rather the fact that Street expectations seem to have caught up to my own and the shares look much closer to fair value now – an issue I noted with PNC Financial (PNC) and Wells Fargo (WFC) in recent articles (here and here) about those two. Do keep in mind, though, that while owning relatively cheaper/undervalued stocks can drive short-term outperformance, there’s nothing wrong with holding onto shares of a well-run business trading at or near fair value, as well-run businesses have a knack for outperforming expectations over time.

This Upcoming Quarter May Be The Bottom

Bank of America hasn’t been doing too badly of late with respect to quarterly earnings reports – each of the five quarters since my last article has seen the bank exceed sell-side EPS expectations, and the last quarter saw a respective pre-provision profit beat (a $0.06/share beat versus an overall $0.09/share operating EPS beat). The bank has done well due in no small part to less pressure on net interest margin from funding (helped by a sizable pool of effectively free funds) and tight expense management, as well as healthy trends in capital markets (both banking and trading).

I do expect a modest reversal of some of these trends in Q2’24. Although Bank of America has been the biggest beneficiary of free funding among its group, I expect some funding pressures and deposit pressures from tax-related outflows to lead to a trough in net interest income and net margin in the quarter, with a NIM around 1.92% or 1.93%. The good news is that this is widely-expect and given BAC’s operating history, I won’t be surprised if there’s a slight beat at the NIM line.

Fee income could perhaps drive some upside. I expect a sequential decline in trading, but Jefferies (JEF) did pretty well for the quarter and Bank of America has been surprising to the good here recently. Banking could also be a source of upside, as Jefferies saw 9% sequential growth here and issuance and advisory markets are picking up after a weak 2023.

I’m not expecting much to come from expenses, as BAC already runs a tight ship, but the bank could squeeze out a penny or two of upside here. All told, I think BAC could deliver something around $9.2B or $9.3B in pre-provision profits versus expectations closer to $9.0B-$9.1B (good for around $0.02 to $0.03/share of upside).

I’m not expecting much good news in lending. Loan growth has continued to slow, with cards up 7% year-over-year in the quarter and C&I lending up less than 2%. BAC had already been lagging on card loan growth and C&I, and I don’t expect either to significantly outperform, though the simple fact that card loan growth is so much stronger than other categories should drive better growth here than for banks like PNC and Truist (TFC).

And From There?

A lot of what happens next for banks like BAC will be determined by what the Fed does with rates over the next six to 12 months. Unfortunately, as a close friend of mine who heads up a major CRE’s economic research effort likes to say, the interest rate forecasting hall of fame is empty for a reason. In other words, your guess is as good as mine, though I do think weaker macroeconomic conditions are likely to put more pressure on prices and coax the Fed to start cutting.

As an asset-sensitive bank, declining rates aren’t likely to help BAC as much as some banks, but I do expect the bank to see a tailwind from repricing its loan and securities books at higher rates, as well as a benefit from lower deposit costs. I also expect BAC to benefit from improving loan demand in 2025 and 2026, and particularly on the consumer side.

I also expect good growth from fee-based businesses. Card fees should reaccelerate as the economy recovers, and I expect Bank of America to leverage more of its past investments into digital payment tech to generate more revenue here. I also expect stronger results from trading and banking to drive growth; while Wells Fargo is also talking about growing these business lines, Bank of America has been performing quite well on a consistent basis, and I think it will continue to do so in the next few years.

While I don’t see as much room to cut costs here as at other banks, the fact that the efficiency ratio is already quite competitive should drive stronger operating leverage as revenue’s recover, as the bank will need to spend less to support that growth. I see all of the above leading to a high-single-digit two-year pre-provision profit growth rate that should be on the higher end of its comp group.

Bank of America Still Has A Runway For Growth

Thematically, I think there are multiple growth targets and opportunities to monitor over the next three to five years.

For a bank with double-digit share of national deposits, Bank of America still punches under its weight in wealth management with something in the neighborhood of 5% market share. Management has made it clear at recent sell-side presentations that this is a business they want to grow, but I want to hear more about the “how” – BAC management has been very focused on expenses in this area, and I think the bank may need to invest a little more (whether that’s technology, personnel, or marketing, or all of the above) to drive better results.

I also see opportunities to grow the cards and mortgage businesses. As the #5 card issuer, Bank of America could be a bigger force than it is, and I think there are opportunities to grow this business without necessarily compromising credit quality. Likewise with mortgages, where management has ceded some share but could be poised to gain as non-bank competitors will still have funding cost disadvantages.

Last and not least, there are still opportunities to grow the core deposit business. Management wants to be #1 or #2 in its 30 largest markets and they still have six left to go. Likewise, management wants to be in 93 of the top 100 markets by 2026, which means adding branches in nine more markets over the next couple of years.

As far as credit quality goes, and apologies for the abrupt segue, I’m not too concerned. Nothing in Bank of America’s recent charge-off, non-performing loan, or criticized loan numbers suggests a brewing problem. While the company does have a large office loan portfolio in absolute terms, it’s less than 2% of overall loans and geographically diversified. What’s more, it will take years for the office credit situation to play out (that’s true of the whole banking sector, not just BAC).

The Outlook

With ample capital to fund both future growth and capital returns to shareholders, I don’t see many compromises necessary between the two. A higher-for-longer rate cycle has negatively impacted my earnings expectations for FY’24 and FY’25 (FY’23 earnings were about 1.5% better than I’d modeled), but I do still expect long-term core earnings growth in the neighborhood of 4% and distributions growth (dividends and buybacks) closer to 8%.

Discounting the core earnings back, I get to a fair value in the low-to-mid-$40’s. I get a similar fair value with an 11.4x multiple to my 2025 EPS estimate ($3.67 vs. Street $3.62) and a 1.65x P/TBV multiple based on a ROTCE near 14%.

The Bottom Line

Perhaps Bank of America can generate even more positive operating leverage than I expect, and/or grow loans, deposits, and capital markets even more than I expect in the coming years. As is, though, while I like Bank of America quite a lot and still consider it a good stock to hold, I don’t see a level of undervaluation that would lead me to prefer it over other names like JPMorgan or PNC at this point.

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Analyst’s Disclosure: I/we have a beneficial long position in the shares of JPM, TFC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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