Bank of America: A $106 Billion Hole Isn't A Problem Until The Fed Says It Is

An Analysis of Bank of America’s Performance Amidst Market Challenges

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Bank of America (NYSE:BAC) faced challenges with declining deposits both quarter-over-quarter (QoQ) and year-over-year (YoY) after the 2023 banking crisis. A significant amount of money flowed into money market funds, reaching $5.45 trillion by June 12, 2023, indicating a substantial YoY increase of 30.6%.

Despite these challenges, we maintained an optimistic outlook for the bank, primarily due to the improving Net Interest Income (NII) driven by sustained interest rate hikes by the Federal Reserve since March 2022. Additionally, BAC’s provision for losses seemed well-managed, thanks to strict lending standards with FICO scores averaging over 770 across its loans.

Bank of America’s enhanced profitability is attributed to the rising interest rates

In FQ2’23, Bank of America reported an impressive performance with revenues of $25.2 billion (down 4% QoQ but up 11% YoY) and GAAP EPS of $0.88 (a decline of 6.3% QoQ but an increase of 20.5% YoY).

The significant expansion in FTE NII to $14.3 billion (down 2% QoQ but up 14.4% YoY) and FTE Net Interest Yield to 2.65% (a decrease of 0.2 points QoQ but an increase of 0.45 points YoY) largely contributed to the profitability. This growth was partly attributed to the increase in the bank’s interest-bearing deposits, reaching $1.27 trillion (up 1.1% QoQ and 4.5% YoY).

Despite the downward trend in total deposit growth, BAC’s liquidity remained intact, with Global Liquidity Sources reaching $867 billion (up 1.5% QoQ but down 11.8% YoY) in FQ2’23.

The Federal Reserve seemed reassured by BAC’s robust liquidity, its safe haven status, and the confidence depositors had in the bank, even though it reported $106 billion of unrealized losses (an increase of 2.9% QoQ and 21.5% YoY) in the latest quarter.

The Impact of Treasury Yields on BAC’s Trading Activities

The higher treasury yields positively affected BAC, leading to increased trading activities, with sales/trading revenues reaching $4.38 billion (a decrease of 13.2% QoQ but an increase of 9.7% YoY) in FQ2’23.

While some investors expressed temporary concerns about the bank’s QoQ moderation, this was mainly due to market fears about the US debt ceiling at that time, as observed in Citigroup’s (C) performance. As market sentiments normalized, trading and investment activities were expected to return to their normal cadence in H2’23, potentially boosting BAC’s non-interest income from the $11.03 billion reported in the latest quarter (a decrease of 6.6% QoQ but an increase of 7.7% YoY).

Addressing Concerns about Macroeconomic Outlook

BAC faced uncertainties in the macroeconomic outlook, as net charge-offs expanded to $869 million (an increase of 7.6% QoQ and 52.1% YoY) with a ratio of 0.33% in FQ2’23 (an increase of 0.1 points YoY), approaching FY2019 averages of 0.38% while surpassing FY2022 averages of 0.21%.

This increase was primarily due to higher credit card losses, coinciding with the total US debt reaching $993.51 billion (an 11.7% YoY increase). However, the reported delinquency rate of 2.43% in Q1’23 (an increase of 0.18 points QoQ and 0.76 points YoY) remained below the 2019 average of 2.58%, providing some reassurance to investors.

However, with Powell hinting at least two more rate hikes in 2023, there was a growing risk that delinquency rates may exceed pre-pandemic averages.

Considering the rising interest rate environment’s impact on expanding NII and NIM, investors may want to pay close attention due to the acceleration in credit card account adds of 1.2 million (a decrease of 7.6% QoQ but an increase of 20% YoY) in the latest quarter.

Nevertheless, BAC’s stable ROTCE performance of 15.5% (a decrease of 1.9 points QoQ but inline YoY) in FQ2’23, compared to FY2019 levels of 15.8%, instilled confidence in the bank’s prospects amid the uncertain macroeconomic outlook.

Income investors may find comfort in BAC’s cautious dividend increases, amounting to an annualized sum of $0.88 (an increase of 4.7% YoY) in the latest quarter, compared to the FY2019 cadence of $0.72 (a 20% YoY increase), as capital preservation remained a priority.

So, Is BAC Stock A Buy, Sell, or Hold?

Evaluating BAC’s 5Y EV/Revenue and P/E Valuations

BAC’s valuations remained impacted at NTM Price/Sales of 2.50x and NTM P/E of 9.85x, compared to its 1Y pre-banking crisis mean of 2.89x/10.22x and 3Y pre-pandemic mean of 3.00x/11.51x, respectively.

Mr. Market seemed uncertain about the bank’s prospects, and the bank’s gross unrealized losses in debt securities might continue to pose a headwind until the rising inflationary pressure subsided.

Nevertheless, BAC’s size and the Federal Reserve’s investment in the stability of the US banking system suggested that it was “almost” too big to fail. As market sentiments improved and the impact of the banking crisis diminished, it was possible to see BAC breaking out of current levels and retesting resistance at $33.

Assessing BAC’s 1Y Stock Price and Potential

Supported by the upward momentum from the previous March 2023 bottom, BAC has the potential to surpass the April 2023 levels and test its next resistance at $33

Most importantly, the stock continued to trade below its book value per common share of $32.05 (an increase of 1.4% QoQ and 7.2% YoY), suggesting a mild undervaluation, especially compared to pre-banking crisis stock prices.

While the recovery might be slower due to the uncertain macroeconomic outlook, confidence in BAC’s long-term prospects remained high, as such headwinds do not last forever.

Therefore, we continued to rate BAC stock as a Buy, anticipating excellent upside potential to our price target of $40, based on normalized P/E valuations and market analysts’ FY2025 adj EPS projection of $3.53.

Income investors might also appreciate the stock’s expanded forward dividend yield of 2.99%, thanks to the recent correction, though it still lagged behind the sector median of 3.80%.


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