Bank Of America: Now Fairly Valued – H2’23 To Bring Forth Rich Interest Incomes (NYSE:BAC)

We previously covered Bank of America (NYSE:NYSE:BAC) in October 2023, discussing the massive pessimism embedded in the stock’s valuations and its mixed prospects, thanks to the mistaken perception that its unrealized losses were growing.

While we continued rating the stock as a Buy here, thanks to the outperformance of its quarterly financial reports, investors might want to brace for impact, since it remained to be seen when bullish support might materialize.

In this article, we shall discuss why we are maintaining our Buy rating for BAC, with the stock’s massive returns of +52.2% well outperforming the wider market at +23% since then.

Even so, the stock is merely fairly valued here, with the bank still generating robust profitability metrics despite the elevated interest rate environment and normalizing loan portfolio losses.

Combined with the (prospective) dual pronged returns through moderate capital appreciation and dividend payouts, BAC continues to offer a viable investment thesis.

The BAC Investment Thesis Remains Promising For A Well-Diversified Portfolio

With the March 2024 CPI still rising and the Fed’s path to a 2% inflation target likely to be prolonged, it remains to be seen when the Fed pivot may occur. For now, most of the market has priced in zero rate cuts through July 2024, with it only expected to occur by the September 2024 FOMC meeting.

This is good news for BAC indeed, given that the higher interest rates may similarly sustain its higher top/ bottom lines, with the bank still reporting decent Net Interest Yields of 2.5% (+0.03 points QoQ/ -0.35 YoY) and RoTCE of 13.8% (+2.1 points YoY/ -3.6 YoY) in FQ1’24.

This is compared to FY2019 levels of 2.91% (+0.49 points YoY) and 14.9% (-0.65 points YoY), respectively.

On the other hand, it goes without saying that as the interest rate environment remains high, BAC continues to face multiple headwinds:

1. The Optics Surrounding HTM/ AFS Unrealized Losses

The unrealized losses have worsened on a QoQ/ YoY basis, with BAC reporting an overall unrealized losses of $112.84B (+10.5% QoQ/ +9.4% YoY) in FQ1’24.

Then again, the truth of the matter is that not all unrealized losses matter, since Held-To-Maturity [HTM] debt securities are “purchased to be owned until maturity.”

We can already see that BAC’s Available-For-Sale debt securities’ unrealized losses have been declining to $3.61B (-9.2% QoQ/ -10.8% YoY), with the moderating loss ratio of 1.1% (-0.3 points QoQ/ -1.3 YoY) remaining reasonable compared to FY2019 ratio of 0.18% and FY2018 ratio of 2.3%.

As a result, we believe that this is an optics issue, with discerning investors likely more than aware of the management’s excellent execution thus far.

If anything, with no more rate hikes ahead and the EU Central Bank signaling their first cut by June 2024, we may see a Fed rate cut occur over the next few months, eventually downplaying the impact of BAC’s HTM unrealized losses.

2. Normalizing Credit Portfolio Performance

As the macroeconomic outlook normalizes, it is more than normal for BAC’s credit performance to normalize as well.

This has been observed in the bank’s expanding overall net charge-off rates of 0.58% (+0.13 points QoQ/ +0.26 YoY) in FQ1’24, higher than the FY2019 levels of 0.38% (-0.03 points YoY).

Despite so, BAC is not the only one facing this issue, with JPMorgan (JPM) also reporting expanding overall net charge-off rates of 1.33% (+0.18 points QoQ/ +0.37 YoY) in FQ1’24, compared to its FY2019 averages of 1.20% (+0.16 points YoY).

The same has been reported by Wells Fargo (NYSE:WFC) at 0.5% (-0.03 points QoQ/ +0.24 YoY) in FQ1’24, compared to FQ4’19 levels of 0.32% (+0.5 points QoQ/ +0.2 YoY).

These numbers imply that BAC’s credit performance remains reasonable compared to its big bank peers, with the “loan book de-risking” already working as intended.

Moving forward, readers may want to take note of the Commercial real estate and Consumer credit card segments (due 30 days or more), since these segments’ nonperforming Loans have been growing at an accelerated rate to $2.27B (+18.2% QoQ/ +352.7% YoY) and $2.44B (+1.2% QoQ/ +46.1% YoY) in the latest quarter, respectively.

With many major credit card lenders also reporting higher average delinquency rate of 3.20% as of February 2024 (-0.4 points MoM/ +0.61 YoY), compared to the 2.85% reported in February 2020, we may see the next few quarters bring forth more uncertainties before the macroeconomic outlook normalizes.

3. Interest-Bearing Deposits & Balance Sheet

With the interest rates still elevated, it is natural that the US Treasuries are still yielding rich yields of between 4.65% – 5.41% as many online banks also offer tempting Annual Percentage Yields [APY] for saving balances, including SoFi Technologies, Inc. (SOFI) at 4.60% and Ally Financial Inc. (ALLY) at 4.20%.

Despite BAC only offering a base APY of 0.01%/ Preferred Reward APY of 0.04% and more liquidity flowing into the Money Market Funds at $6.49T by April 17, 2024 (+14% YoY from $5.69T/ +58.7% from 2019 levels of $3.88T), BAC continues to report growing interest-bearing deposit to $1.38T in FQ1’24 (+1.4% QoQ/ +9.5% YoY/ +38% from FQ4’19 levels of $1T).

This is also why BAC has been able to report a relatively healthy Global Liquidity Sources of $909B (+1.3% QoQ/ +6.4% YoY) and an excellent Net Interest Income of $14.03B (+0.6% QoQ/ -2.8% YoY), further demonstrating that the March 2023 US banking crisis is already well behind us.

BAC’s Management Of Excess Deposit

If anything, BAC has demonstrated competent deposit monetization, with the management still reporting a blended cash/ securities yield of 3.6% – higher than the deposit rate paid at 1.93% in FQ1’24.

While there may be Q2 headwinds as “the clients in wealth management make their seasonal income tax payments,” the bank has already guided promising deposit and NII growth in H2’24, as the “replacement of lower earning assets into higher yielding assets continues to provide an ongoing benefit to NII” ahead.

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

BAC 4Y Stock Price

For now, BAC has already charted an impressive recovery of +53.5% since the October 2023 bottom, well outperforming the wider market at +23% while running away from its 50/ 100/ 200 day moving averages.

As sentiments turn bullish, the stock also finally trades above its book value per share of $33.71 (+1.1% QoQ/ +6.7% YoY), nearer to its pre-banking crisis days.

With BAC now fairly valued according to book value, its forward dividend yields have also moderated from the recent peak of 3.58% to 2.45% at the time of writing.

Does this mean that BAC no longer offers a viable investment thesis? Not quite.

The Consensus Forward Estimates

Thanks to its robust profitability and the sustained operating efficiencies (partly attributed to the -2.1% headcount reduction on a YoY basis), the consensus have moderately raised their forward estimates, with BAC expected to generate a top/ bottom line expansion at a CAGR of +3.1%/ +8.1% through FY2026.

This is compared to the previous estimates of +1.4%/ +3.4% and the historical expansion of +2.2%/ +10.8% between FY2016 and FY2023, respectively.

BAC Valuations

With BAC’s FWD P/E valuations of 11.89x also recovering from the March 2023 bottom of 7.9x and nearing its 3Y pre-pandemic mean of 11.53x and 5Y average of 11.76x, the stock appears to be fairly valued indeed, especially when compared to its peers such as JPM at 11.94x and WFC at 12.21x.

Based on BAC’s FWD P/E valuations of 11.89x and the LTM adj EPS of $2.89, the stock appears to trade near our fair value estimates of $34.30.

Based on the consensus FY2026 adj EPS estimates of $3.89, there seems to be a more than decent upside potential of +20.5% to our long-term price target of $46.20 as well.

As a result of the relatively attractive risk/ reward ratio, BAC remains a Buy for investors looking to diversify their portfolios as the management continues to generate alpha no matter the uncertain macroeconomic outlook.