Bank of America Q3 Preview: Erica AI To Power Growth

Summary:

• Despite the stock’s decline since the summer and Warren Buffett’s share sales, I believe Bank of America’s AI investments, particularly Erica, will sustain growth and improve operational efficiency.
• The Federal Reserve’s interest rate cuts and BAC’s strong consumer spending trends present economic tailwinds, making the current market sentiment overly cautious.
• Analysts’ conservative EPS projections for Q3 may be exceeded due to BofA’s AI-driven efficiencies and robust performance in investment banking and capital markets.
• With my estimate of fair value at a P/E of 17 times earnings, BofA shares have significant upside potential, supported by AI-driven cost savings and strong consumer engagement.

Investment Thesis

Bank of America (NYSE:BAC) shares have fallen by 3.25% since my last coverage over the summer, due to the market pricing in lower interest rates and Warren Buffett’s offloading over $10 billion worth of BofA stock. Buffett’s sales have made some investors concerned that the bank’s earnings may have already peaked​ and that’s why he is unloading his shares.

Personally, I disagree with this. While some market participants are concerned about the future earnings potential of BofA, I believe their $4 billion worth of investments in AI through their AI assistant Erica, which has already facilitated over 2 billion interactions, will sustain the bank’s profit profile through far more efficient customer interactions and personalized gestures that keep customers coming back.

As one of the nation’s largest banks continues to invest in AI, I feel confident that these advancements will improve their global operations. Despite current market skepticism, I remain a strong advocate for BofA as a strong buy, particularly as we approach their Q3 earnings. The potential for AI to transform customer engagement and increase their operational capacity is key to their future. I think they are executing well.

Why I’m Doing Follow-up Coverage

Bank of America shares have lagged the market since my last analysis in July, with shares falling around 3.25% while the S&P 500 has gained 3.72% during the same period​. In my view, this seems unjustified, given the bank’s solid operational management and the Federal Reserve’s recent decision to cut interest rates by 50 basis points.

The Fed’s decision to lower rates aims to support the US economy amid now softer inflation​. I think BofA can take advantage of this. I mentioned this over the summer, but the bank should continue to benefit from increased deal flow as interest rates decline. AI will help keep the margins stronger in their consumer lending divisions.

I think the market sentiment towards BoFA is too cautious. Given what, I believe, are economic tailwinds (not headwinds) from lower interest rates, the potential for earnings upside is possible, and AI will help them out. I think this warrants follow-up coverage.

Q3 Preview

Analysts expect BofA to report an EPS of $0.76 for Q3, which would be a 15.36% decrease from the same quarter last year​.

However, I believe these expectations are conservative and websites like Earnings Whisper seem to agree, with their whisper EPS coming in at $0.82/share.

Beyond the AI which, I think, is driving efficiency (I’ll talk more about this later) the bank’s investment banking and capital markets should continue to ramp up and offer them increased deal flow as firms look to refinance & restructure their debt in this slightly lower interest rate environment.

On the consumer side, the bank continues to perform well despite fears of the current economy. CFO Alastair Borthwick dove into this during the 29th Annual Financials CEO Conference:

And I’d say the United States right now, obviously, is experiencing a period of some growth. When we look at the consumer side of our equation, as you point out, we’ve got a pretty good window into what the consumer is doing in the United States. When we look at combined credit and debit spend, last year was a record year in terms of just consumer spending. And this year, that continues with, today, consumer spending up another 4% or so, that had briefly touched 3%, sort of rebounded a little bit towards the 4% number.

And when you consider that the consumer still remains 70% of the U.S. economy, that gives you a sense from just what the underpinnings are of economic activity there right now. It’s a pretty good place. And if we look forward, you can understand why the consumer is doing well. The employment picture is still in a good place. Income is still in a good place. When we look at the deposit balances for our own customers per account, they’ve come down a little bit. But at the very low end of the consumer, they’re still 2.5 times, 3 times higher than where they were pre-pandemic. So they spend down balances a little bit.

In terms of international bank franchises, CFO Borthwick added:

…if you think about where we stand, about 40% of our markets and investment banking business comes from international clients and international activity. So it’s already pretty substantial.

The growth rate over the past several years has been around 7%. So again, you can sort of see how we’re growing faster than global GDP, in large part because we’re taking market share in both the Global Markets business and in the Investment Banking.

CEO Brian Moynihan shares the same sentiment when he spoke at the 22nd Annual Global Financial Services Conference in September:

We’ve been in Argentina since 1914. Brazil since ’54, I think it was you go to India over 65 years, I think, this year, so the idea is we’re in these countries for a long period of time. And so we’ve been able to keep maturing the franchise along those dimensions. But there’s still opportunity. And that’s where Matthew and the team have looked to take — to go a little deeper on the client base to privately owned businesses of size, but are consistent with the businesses we operate on a global basis or involve the global supply chain, and that presents another opportunity for us.

Really what I am trying to show with this qualitative data is that the bank has a lot of places (both in the US and globally) where they feel like conditions are good. This runs contrary to this cloud of pessimism that is overhanging the company in light of Buffett selling off some of his shares.

How Erica AI Is Helping

Since its launch at BofA in 2018, Erica has facilitated over 2 billion interactions by assisting roughly 42 million clients with their financial needs, from managing subscriptions to providing spending insights​.

I think what’s key here is that Erica lays the foundation for the bank to do more with AI for its customers. Part of the science of a large enterprise integrating AI is getting consumers to use it as well. We’re now starting to see that, and I think that’s why the bank is now allocating an additional $4 billion to technology enhancements, including AI capabilities.

The AI assistant’s predictive analytics and cognitive messaging functionalities allow it to deliver personalized financial advice and support 24/7.

Bank of America has found that their clients typically receive answers within 44 seconds, and over 98% find the information they need quickly. I think this is a huge value add. Erica can also help consumers with routine inquiries like account numbers, routing numbers, and transaction assistance.

I think this has helped Erica foster customer loyalty by engaging with US consumer customers on a personal level, even sending birthday wishes to clients.

Erica lays the foundation for the holy grail of where AI can help in consumer functions: customer service calls. OpenAI’s GPT-4o presents a massive opportunity for banks to leverage AI-driven call centers to raise their efficiency and reduce costs. This latest model boasts advanced capabilities such as real-time reasoning across audio, vision, and text to streamline customer interactions. It’s now getting cheaper and, for many functions, can be just as useful as a human for basic inquiries. This will be a massive cost savings for the bank.

Experts believe that the integration of GPT-4o into customer service can lead to fully autonomous call centers, creating this massive potential for cost savings​.

Valuation

With the core business still performing well and AI helping to make their consumer business more efficient, I think BofA should be trading at approximately 17 times forward earnings to better reflect the bank’s cost-saving initiatives and consumer-focused strategy.

Currently, the bank has a forward P/E ratio of 12.57, higher by 4.66% than the sector median of 12.01.

Keep in mind that earnings and revenue estimates have both seen net negative revisions over the last 3 months. While I think lower interest rates do push forward revenue down, this doesn’t mean that EPS will necessarily suffer. AI has the potential to allow the bank to do more with less revenue.

I believe that the potential for operational efficiencies supports a valuation increase. A shift to a 17 times forward earnings multiple indicates significant upside potential. Using the consensus earnings estimate of $3.20 per share for this year ending December 2024,​ and the current trading price of $39.88, this represents an upside of 36.40%.

Risks

I think the biggest elephant in the room is Warren Buffett’s share sales, where Berkshire Hathaway has reduced their stake in BoFA by approximately 23%, selling about $10 billion worth of stock since mid-July. I think this is a big reason there has been a decline in BofA’s stock price over the past few months​ (this is a lot of supply to hit the market).

While Buffett’s decision to sell might raise concerns among investors, I think that this is a strategic adjustment rather than a sign of financial distress for the bank. By reducing his stake to below 10%, Buffett can relinquish the status of an insider, which allows him greater flexibility in managing his investments. The current ownership level places Berkshire Hathaway on the cusp of this threshold​. I think once we see this % drop below 10% we should see selling dissipate.

Bottom Line

BofA’s shares have dropped slightly since my last writeup because of market adjustments due to lower interest rates and Warren Buffett’s offloading roughly $10 billion worth of stock.

Despite this bearish sentiment, I believe their investments in AI through their Erica assistant, which has already facilitated over 2 billion interactions, will sustain growth moving forward while keeping costs down.

Their continued rollout of AI-related projects through this new $4 billion tech budget should set the bank up well for Q3 and Q4, as they continue to improve customer engagement and operational efficiency.

With this, I still think BofA’s shares are a strong buy. The Charlotte, NC-based bank’s investments in AI and really overall solid commentary on their current market outlook puts the bank in a good spot for resilient profits. I feel good about where shares can go from here.

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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.

Noah Cox (main account author) is the managing partner of Noah’s Arc Capital Management. His views in this article are not necessarily reflective of the firms. Nothing contained in this note is intended as investment advice. It is solely for informational purposes. Invest at your own risk.

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