Bank of America: Triple Whammy Ahead
Contributor since 2019 / 2178 Followers
Summary:
- Investing in Bank of America is risky due to rising non-performing real estate loans and upcoming property tax hikes, especially in New York and California.
- The belief that interest rate reductions will benefit BAC is flawed, given the significant challenges in the commercial real estate sector.
- The combination of rising property taxes, declining demand for commercial real estate, and potential losses on mortgage-backed securities creates a “triple whammy” for BAC.
- Investors should closely monitor BAC’s upcoming quarterly report for further insights into these troubling trends.
tupungato
Preamble
In my view, there are so many reasons why an investment in the banking sector is a terrible idea right now, that I could easily cobble together several articles on the topic in short order. Indeed, I have recently written one about the regional banks titled; “The Fed Cannot Save The Banks.”
This piece focuses on the widely held belief that an interest rate reduction or two will benefit Bank of America Corporation (NYSE:BAC), given that the bank is suffering from the effects of an increase in non-performing real estate related loans. However, countering this perceived benefit are the upcoming hikes in property taxes.
For the purposes of this article, I propose to provide a brief analysis of the effect of rising taxes, using New York as an example, given that the majority of BAC’s commercial real estate loans are in this state. The tax increases are significant, and when combined with the challenges in the commercial real estate market, they are likely to result in reduced profits for BAC.
Bank of America
The Bank of America Corporation operates through four primary segments: Consumer Banking, Global Wealth & Investment Management, Global Banking, and Global Markets. The bank has a vast presence with operations across the U.S., serving around 69 million consumer and business clients.
The bank’s involvement in property-related business is multifaceted. In Consumer Banking, it offers residential mortgages and home equity loans, which together constitute a significant portion of their consumer loan portfolio. To quote from their most recent Form 10-Q; “The residential mortgage portfolio made up the largest percentage of our consumer loan portfolio at 50% of consumer loans and leases as of June 2024.”
The Global Banking segment also has exposure to the property sector through commercial real estate loans, primarily extended to developers and real estate firms. The commercial real estate portfolio is diversified across property types, with office loans being a notable component. As of June 30, 2024, office loans represented 23% of the commercial real estate portfolio and roughly 2% of the bank’s total loans (Page 36).
The bank also engages in mortgage securitization, transferring a portion of its mortgage loans into securities, primarily backed by agencies like Fannie Mae and Freddie Mac. The bank maintains some beneficial interests in these securitized trusts; “The Corporation may retain beneficial interests in the securitization trusts including senior and subordinate securities and equity tranches issued by the trusts.” It goes without saying, non-performing loans within these securities will exert a downward pressure on their valuation.
Indeed, there have been losses on these Mortgage Backed Securities. Form 10-Q shows that as of June 30, 2024, there were gross unrealized losses of $2.4 billion on Available For Sale debt securities, which is found on page 64 of the document. True, this represents a mere 0.01% of the Fair Value, nevertheless, the trend is up, rather than down, as we may note from the data on net charge offs and non-accruals.
Net Charge Offs
The net charge-offs, which indicate debt unlikely to be paid, increased significantly year-over-year. For the three months ended June 30, 2024, they increased by 76.41% compared to the same period in 2023 ($869 million to $1,533 million). These losses were primarily due to credit card loans gone bad and the commercial real estate portfolio. For the six months ended June 30, 2024, the increase was 80.85% compared to the corresponding period in the prior year ($1,676 million to $3,013).
Bearing in mind that banks are not keen to foreclose on property, especially in an environment of low demand. This is because the banks will be saddled with additional costs, which include the ongoing costs of property tax. This unfortunate state of affairs is often referred to as a “double whammy” in financial parlance.
In fact, one could go on to say that the bank may experience a triple whammy if you factor in potential losses on their portfolio of mortgage-backed securities.
As mentioned, another area of concern for BAC is the level of non-performing loans; non accruals.
Non-Accruals
On page 66 we can find information concerning late payments, otherwise known as non-accruals. The total loans and leases over 30 days late in payment, excluding credit cards, is $5,553 million, which is around 0.5% of the total loan portfolio.
A fair point to note is that the figures for non-accruals is similar to a year ago.
Commercial Real Estate
There have been numerous reports of declining demand for commercial Real Estate. For instance, Fitch and Co claim there is a secular decline in demand for space.
In fact, Bank of America confirm that this situation is a potential headwind for the company. To quote; “Recent demand for office space has been stagnant, and future demand for office space continues to be uncertain as companies evaluate space needs with employment models that utilize a mix of remote and conventional office use.”
As of June, BAC had $70,284 billion of CRE loans outstanding, around 23% of which is in the Northeast, which includes New York. So, it would be interesting to determine what is happening tax wise in this area.
New York
According to a news report, numerous Wall Street firms are shifting their operations from New York to other states, primarily in the South, such as Florida and Texas. This exodus is driven by several key factors, including high crime rates, burdensome taxes, and a soaring cost of living in New York.
The financial implications of this trend are substantial, not only do these firms pay a substantial amount in local taxes, but they support thousands of high-paying jobs. The loss of tax revenue and economic activity is reported to be a serious concern for New York, and, by implication, Bank of America.
Lower costs, particularly for office space and living expenses, are a major draw for companies moving to cities like Dallas and Nashville. Additionally, some states offer attractive tax incentives to entice businesses to relocate.
As businesses flee New York, which will ultimately lead to a loss of revenue for the state, there are additional burdens that must be paid for, such as the circa 100,000 newly arrived migrants. The estimated cost of these arrivals can be measured in the billions of dollars.
Tax Hikes
According to the Department of Finance, New York City, property assessments have been completed.
Armed with this data, some analysts have concluded that; “The tentative assessment rolls reflect an overall total market value increase of 0.7% for all New York City properties. Citywide taxable assessed values increased by 4.2% percent. Many commercial property owners were surprised by these increases given the ongoing distress across the market—particularly in the office sector, which saw market value increase 3.18% overall on the new assessment roll.”
Other specialists in the property sector concur with the findings given above for commercial real estate; “This year’s rate would be the third highest in 20 years. Combined with the +3.47% increase in taxable assessed value, we estimate taxes will increase +4.4% overall.”
Given the size of the expected increase in property tax, it will act as a kind of counterweight to a modest cut in interest rates.
The situation in California mirrors that in New York in many ways.
California
BAC has $14,085 billion in CRE loans outstanding in California, which represents around 20% of their portfolio. The state is experiencing similar travails to New York, businesses leaving the state and ballooning expenses.
Reading the state’s fiscal outlook, we can discover that the state has a $68 billion deficit, primarily due to “a severe revenue decline in 2022-23.” There are a couple of conclusions we may come to reading this, which do not bode well for BAC. Firstly, California needs to plug this hole, which means either cutting spending, leading to lower economic activity. Alternatively, increase the financial burden on both citizens and businesses. Either way, it’s all bad for CRE, and suggests the outlook for BAC cannot be described as rosy.
Outlook
BAC released their quarterly report in July, so we can expect the next report in October. I for one, am eagerly awaiting details to determine whether these trends in CRE are accelerating or not.
Summary
I would argue that the widely held belief that interest rate reductions will benefit Bank of America is flawed.
The bank is facing challenges from increasing non-performing real estate loans, particularly in the commercial real estate sector. The upcoming property tax hikes, especially in key markets like New York and California, will further strain the CRE sector.
The combination of rising property taxes, declining demand for commercial real estate, and potential losses on mortgage-backed securities creates a “triple whammy” for Bank of America.
Given these circumstances, investors may well conclude that there is a strong need to closely monitor the bank’s upcoming quarterly report for further insights into these trends.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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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