LunaKate
Bank of America (NYSE:BAC)’s shares have rallied 10% so far in FY 2024 on expectations that the Federal Reserve will delay its rate pivot and not push for a lower federal fund rates in the very short term. The change in the Fed’s tightening policy obviously benefits large Wall Street banks like Bank of America which will allow them to generate stronger net interest income for longer. The U.S. economy is also doing great, despite higher than expected inflation in February, which should also serve to help out Bank of America’s consumer business. As a result, I am changing my rating on Bank of America to hold!
Previous rating
It obviously was a bit premature to call for the official end of the current interest rate cycle which is what I did when I wrote The Fed Just Made Bank of America A Sell, in mid-December 2024. In this work I indicated that the end to the current tightening cycle would pressure the bank’s net interest margin and, potentially, Bank of America’s book value multiplier. An uptick in inflation in early 2024 derailed this narrative, however, and I am therefore changing my rating from buy to hold.
NIM pressures are not as pressing as I assumed
The main mistake I made in my last work on Bank of America was to assume that the Federal Reserve would lower its federal fund rate quickly and thereby pressure the bank’s net interest margin. Bank of America’s net interest margin did decline in the fourth-quarter, as I believe everyone projected, to $14.1B… which marked a 5% Y/Y drop. It was the third quarterly decline in the bank’s net interest income in FY 2023, although not consecutively. While we have most likely seen the peak in interest rates, a higher for longer rate world obviously will benefit Bank of America’s large consumer loan portfolio.
Bank of America
Bank of America’s loans are still growing (+1% Y/Y in Q4’23) which are backed by a strong economic trajectory in the U.S. with unemployment still being below 4%.
Bank of America
Bank of America’s consumer loan quality is also still very good. The consumer loan portfolio showed a non-performing loan ratio of 0.59% in the fourth-quarter which was practically unchanged from the year-earlier period. This tells us that Bank of America’s consumer loan portfolio is performing very well and that a deterioration in asset quality, which is often driven by a down-turn in the economy, is not yet a concern for the bank or its investors.
Bank of America
What I also seem to have underestimated in my last work on Bank of America in December is that the U.S. economy is doing quite well right now. In the fourth-quarter, U.S. GDP grew at an annualized rate of 3.2% which provides tailwinds for the bank’s cyclical consumer business. In the fourth-quarter, this segment stood out once again with a strong performance sheet with $2.8B in earnings, the most of any segment.
Bank of America
Price-to-book premium
One of my primary concerns last time I wrote about Bank of America was the bank’s relatively large premium to book value which I suggested was inappropriate considering that the Federal Reserve was to set to transition into a period of quantitative easing. This indicated a cyclical decline in the consumer banking segment and also raised the risk of headwinds for the loan business. A low-interest rate world makes lending less attractive from a profitability point of view as banks can charger borrowers lower interest rates for their personal loans or credit cards.
The higher for longer rate situation and the U.S. economy’s solid performance, however, have devalued this narrative. Bank of America has also been able to grow its book value in the fourth-quarter, which rose 2% Q/Q to $33.34 per-share. Currently, Bank of America is valued at a price-to-book ratio of 1.11X. The 5-year average P/B ratio for Bank of America implies a 12% premium to book value so from a historical valuation perspective the Wall Street bank may be about fairly valued. My personal fair value estimate corresponds to the bank’s reported book value which is currently $33.34 and this regard, Bank of America may be slightly overvalued (by approximately 11%).
From an earnings perspective, Bank of America is trading at 10.9X FY 2025 earnings which represents a 3% premium to the large-cap industry group average P/E ratio of 10.6X. The industry group includes the top 4 Wall Street banks by size Bank of America, Citigroup (C), Wells Fargo (WFC) and JPMorgan Chase (JPM).
Risks with Bank of America
Bank of America obviously benefits much longer from the Federal Reserve’s monetary policy support. If the Federal Reserve were to withdraw this support in the near term, which could only be the case if inflation dropped extremely rapidly in the near term, then Bank of America would face stronger net interest margin headwinds. From a consumer banking point of view, the strong constitution of the U.S. economy is likely a tailwind for the bank’s earnings growth in FY 2024.
Closing thoughts
My call to sell Bank of America in December obviously was a bit premature. Considering that both the U.S. economy as well as the inflation picture (higher for longer interest rates) favor banks with large, rate-sensitive consumer loan portfolios, like Bank of America, I believe that a rating upgrade to hold properly accounts for my misjudgment of the macro landscape in December. However, I do not believe that Bank of America’s shares are a buy at this point due to valuation concerns and the fact that the medium term picture overwhelmingly indicates federal fund rate cuts between in 2024 and thereafter!
