Bank of America: Impressive, But Still Concerning
Contributor since 2011 / 24742 Followers
Summary:
- Bank of America Corporation is operating from a position of relative strength despite industry challenges and risks to the sector.
- The bank’s stock price has fluctuated due to the impact of higher interest rates and the banking crisis.
- Bank of America has maintained stable net interest income and has a stable deposit base, but there are risks associated with the business model.
Brandon Bell
When the (regional) banking sector was facing turmoil in March, I believed that Bank of America Corporation (NYSE:BAC) was operating in a position of strength, but it was facing similar industry challenges.
Big banks might benefit from deposit inflows from smaller banks, but such reasoning only applies if you believe that deposits remain within the banking system, as money can go elsewhere as well, of course.
Being cautious on the entire sector amidst narrowing interest rate margins and large unrealized losses, the big banks were operating from a position of relative strength, not to be confused by actual strength, of course. So far this year, the banks have performed very well, but there are still risks to the sector at large here, making me cautious to get involved despite dirt-cheap earnings multiples.
Creating Some Perspective
Bank of America was a $35 stock pre-pandemic as shares fell to the low twenties with the pandemic breaking out, as investors feared ballooning credit losses with large parts of the economy being shut. Shares recovered in a huge fashion in 2021 as shares rose to the $50 mark when 2022 arrived, trading at their peak.
Shares already fell to the low thirties at the start of 2023 as investors were pricing in the impact of higher interest rates, and shares traded around the $30 mark in the spring of this year when the banking crisis arrived.
The 2022 results revealed that annual sales rose in a modest fashion to $95 million, driven by a ten billion dollar increase in net interest income rose to $52 billion, while non-interest income fell to $42 billion. Pre-tax profits fell about ten percent to $31 billion, due to a $2.5 billion credit loss provision (compared to a $4.6 billion reversal of such provisions in 2021). Adjusted for these items, the bank saw earnings on the increase.
The bank, like all banks, was facing two issues. The first was that after taking in record amounts of deposits post-pandemic, banks were slow to hike deposit rates after the Fed started raising rates, resulting in deposits flowing out, while risk-free rates were much higher than deposit rates being offered. The other was that deposits were key, as banks otherwise had to sell assets (and incurring losses given their duration risks) if they did not have other sources of liquidity.
The bank paid out $3.0 billion to depositors in the fourth quarter of 2022 on a $1.9 trillion deposit base, equal to about 60 basis points per annum, all while T-Bills were trading in excess of 4%. The bank fortunately had $230 billion in cash and equivalents to finance outflows of deposits, as the bank was actually taking in some deposits from less creditworthy banks during the tumultuous times, yet if liquidity would be depleted the bank would face issues.
The company carried $862 billion in debt securities of which $633 billion held-to-maturity at costs on which the company reported a $113 billion unrealized loss by year-end 2022, a substantial amount with equity posited at $273 billion.
Caution Prevails
After a few episodes of banking unrest in March and May of this year, the banking sector recovered as fears about its health subsided over the summer. Shares of Bank of America rose from the high-twenties to the low-thirties over the summer, but have come down again, now trading at $26 and change, marking the lows seen this year. This comes as the banking sector is seeing continued pressure on earnings amidst deposit rates being hiked, all while interest rates have made another move higher.
In April, Bank of America posted solid first quarter results with revenues up 13% to $26.3 billion, actually driven by net interest income of $14.4 billion. Following a $0.9 billion in credit loss provision, net earnings to investors were reported at $7.7 billion, equal to $0.94 per share. The balance sheet shrank by just over a percent to $3.18 trillion, while deposits were down 8% to $1.91 trillion, and down twenty billion dollars on a sequential basis.
Second quarter revenues fell to $25.2 billion, although still up significantly on an annual basis, as net interest income fell to $14.2 billion, with net earnings down to $7.1 billion, equal to $0.88 per share. The balance sheet was flattish at $3.18 billion as deposits fell to $1.88 trillion, although that cash and equivalents were still substantial.
Third quarter sales were flattish at $25.2 billion, with net interest income reported at $14.4 billion. The bank maintained profitability at $7.3 billion, or $0.90 per share while the balance sheet shank to $3.13 billion, while deposits were actually flat at $1.88 trillion.
What Now?
The truth is that Bank of America is posting relatively flattish deposits and balance sheet trends, and in fact has managed to keep net interest income nicely flat at $14 billion and change for quite a few quarters now. By now, the interest rate paid on deposits has increased to 1.5%, as this is sufficient to avoid deposit outflows (at least for now, with risk-free rates around 5%) as the huge gap between both metrics is the true risk in the business model of course.
This is certainly the case as the company has some $136 billion in unrealized losses, but has a stable deposit base and plenty of liquidity to avoid outflows. From an earnings point of view, the situation looks quite compelling with earnings trending close to $3.50 per share here, for a mere 7 times earnings multiple. Moreover, the company hiked the quarterly dividend to $0.24 per share, for a yield near 4%.
Quite frankly, this looks quite compelling as the bank is certainly benefiting from its size, with regional banks paying higher deposit rates, and still often witnessing deposit outflows.
That being said, the business has some flaws as well, and while the sticky and low-cost deposit base is positive, it can be a risk as well. After all, a more than 3.5% gap versus risk-free rates could in theory cost the business $70 billion per annum if all deposits would migrate until the gap with risk-free rates is closed, which, of course, is not a reality, but other banks pay higher rates here as well.
Amidst all this, I like the current performance and think that Bank of America Corporation is doing fine, but there are some risks as well. Given this, shares arguably look cheap, and likely are cheap, but I fail to have conviction for the sector at large.
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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