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Investment Thesis
Since my last research piece, Bank of America (NYSE:BAC) shares have outperformed the market, with a total return of 12.59% as of the time of this writing. I believe this indicates that the bank has been operating well, and I think they are set up well to perform going into their next earnings report on July 16th.
Bank of America has been gaining market share, specifically in investment banking and capital markets. This is good for the bank, considering that investment banking activities are expected to continue to rebound as interest rates decrease. While interest rates have been high due to the inflation post-pandemic, they have been trending downward, and current street estimates predict that the Federal Reserve will begin to cut, with some saying this will start in September.
With this, I think another driving factor for deal flow growth will be their credit restructuring initiatives with private equity funds and innovative debt deals. These restructuring efforts are expected to provide the bank with a more stable credit underwriting environment, enhancing profitability and growth prospects, while also boosting fee revenues. PE firms and companies are in a tough spot and many need to refinance debt. As interest rates come down, they will need to leverage the services BofA offers. I’m optimistic.
Whole Bank of America’s balance sheet still shows Held-To-Maturity (HTM) losses, the size of these losses have dropped and are expected to drop further, which is a positive sign for financial health.
With the combination of a strong operational setup, improved market positioning, and effective credit restructuring service, I am a strong buy heading into the next earnings report.
Why I Am Doing Follow-Up Coverage
Since my last coverage of Bank of America in April, the stock has beaten the S&P 500 rise of 7.16%. Part of what I think is driving this is the market realizing the bank is honing in its loan risk management strategies. In the last earnings report back in April, delinquency rates were improving. During the Q1 2024 earnings call, Alastair Borthwick, CFO noted:
we’re encouraged by the trend of delinquencies because the late-stage increases slowed and early stage delinquencies improved as well – Q1 2024 earnings call.
Considering my last piece was written before earnings, I think it is crucial to revisit the status of their loan portfolio. Having low default rates is obviously beneficial for the bank, and I think they are in a strong position to ride the next wave of dealmaking. This article also serves a purpose of explaining what I think the new upside potential for Bank of America is.
Earnings Expectations
Approaching Bank of America’s earnings announcement (scheduled for July 16th) for the second quarter of 2024, the consensus EPS estimate stands at $0.80, an 8.87% decrease year over year. I actually expect this estimate to look low in hindsight. As Piper Sandler noted in their recent upgrade of Bank of America (see valuation for a more detailed analysis), their net interest margins are likely to go up from here as the costs of deposits go down. Coupled with the higher deal flow and I think we could see a stronger than expected EPS.
For revenue, the current street estimate is $25.23 billion, a 0.12% increase year over year. Substance wise, I think a critical aspect to watch will be how the bank’s investment banking and capital markets divisions perform in this. This is where I think we can see the biggest upward variance.
More specifically, I’ll be looking for the deal-flow pipeline. During the Bernstein 40th Annual Strategic Decisions Conference on June 11th, Bank of America’s CEO Brian Moynihan discussed deals with PE firms:
for the private equity firms and our buyouts, the ones we do business with, which are a lot, but we also are trying to help them when they’re buying $0.5 billion company or $1 billion company as opposed to the biggest deals. And so we got a lot of room to grow on that -Bernstein Conference.
Considering that a large portion of PE buyouts are within this target range, like Moynihan said, this is a huge deal flow base they can tap. To me, this affirms their investment bank deal flow has strong upside.
He also went on to talk about deal flow within other sectors such as cash management:
And then the cash management, that’s all together we’re making hundreds of millions of dollars a year investments in cash management generally to have that digital capability and cash pro and everything. But on top of that we’re driving the international piece of that heavily because the enablement for real time payments in India, the enablement for we do some stuff we already do most of like the bank notes program all around the world is something we do. That market share is very high -Conference Transcript.
This is one of the sectors that I mentioned previously where Bank of America has been gaining market share. The bank seems to be increasingly competitive in the cash management space, which provides payment processing services and short-term cash management services for large corporations. This generates fairly high margin, consistent cash flow revenues for the bank, supplementing their business model away from just lending and traditional banking.
In addition, Moynihan adds to this:
But other stuff we have a lot of room to grow for corporates and moving money. And so we’re building out that cash management. So it’s 15% of our revenues, it’s growing, it’s in the GCIB space and larger corporate space. It is $100 billion in outstanding loans. So it’s a big business now and we keep investing in it -Conference Transcript.
Considering this business line is already 15% of their revenue, and it is growing, I think this could be very beneficial for Bank of America. The quotes above were taken from a conference in early June; therefore, I am looking for similar testimonies about their progress during this upcoming earnings call.
Capital return programs are going to be key for me as well. On June 28th, the bank announced that after a successful Fed Stress test they are planning to increase their return of cash to shareholders through an increased quarterly dividend (up by 8% to $0.26 per share), starting in the third quarter of 2024.
During the Bernstein Conference, the topic of returning cash to shareholders was mentioned. Moynihan stated:
So organic growth then basically pay the dividend, which is a $2 billion carry a quarter to — at the current nominal levels and then use the rest of them get back to the shareholders -Conference Transcript.
I like this a lot. Management is demonstrating not only Bank of America’s strategy to return cash to shareholders, but they’re also emphasizing how big of a priority it is even in spite of the large investments they are making.
Valuation
One of the key aspects I would like to point out about the bank’s valuation is their upward revisions in street EPS predictions. In the last 3 months, there have been 16 upward revisions and only 2 downward. Despite this, the bank’s earnings are not forecasted to grow significantly over the next few years. The EPS estimate for December 2024 is $3.23/share, while the EPS estimate for December 2028 is only expected to increase to $3.57. This is less than 10% growth.
While this outlook may be concerning to some analysts, I believe this outlook is misguided, especially given the combination of share buybacks and improving deal flow, which suggest that the bank’s future earnings potential is being underestimated.
Seeking Alpha’s quant rating has classified Bank of America as a strong buy, highlighting the bank’s solid financial health and growth prospects. With the recent rating upgrade from Piper Sandler, I believe this reinforces this positive outlook. Piper Sandler has revised their stance of Bank of America to neutral, the reasoning for this being, as stated by analyst R. Scott Siefers:
With BAC’s NII likely to trough this quarter and then begin a more powerful inflection upward, we no longer see [a] compelling reason to single out the name for underperformance -Piper Sandler Note.
Looking more specifically into the NII margin predictions, he expects them to decrease in Q2 to roughly $13.9 billion and then increase by Q4 2024 to $14.5billion – $14.6 billion. Siefers also estimates that over the next few years, net interest margins will normalize around 2.30% – 2.40%. With expanding NII margins, Bank of America will have to pay less to depositors, increasing bank performance.
Bank of America’s current forward Non-GAAP P/E stands at 12.83, which is 20.80% higher than the sector median of 10.62. However, given the accelerating deal flow I mentioned previously and the expanding NII margins, their P/E should be closer to 15 to account for what I think is underestimated EPS growth in the future. I believe their forward EPS is likely being underpriced, but if the P/E were to increase closer to 15, I think we would see shares reach a more fair valuation with what I believe are solid tailwinds powering the bank.
With this, if shares move up from a P/E of 12.83 to 15, we could see around 17% upside in shares not taking into account buybacks or the higher dividend. I think this is a compelling proposition.
Risks
While I think Bank of America presents a strong investment case, I think the most significant risk that could derail them is the potential impact of a slowing economy, which could lead to rising default rates.
Economic downturns typically result in higher unemployment rates and reduced consumer spending, both of which can negatively affect the bank’s loan portfolio.
However, while I believe the economy is realistically set to slow and overall default rates may increase, I am also not too concerned about defaults in the Bank of America loan portfolio, as the bank seems to have it under control. During the Bernstein Conference, Moynihan stated:
what we’re seeing is the five and 30-day delinquencies have tipped back, flattened out. And so we’re pretty comfortable that with our customer base and the cards -Conference Transcript.
While there are inherent risks associated with investing in Bank of America, I think the bank’s default risk management strategies and financial health mitigate these concerns. The bank is clearly controlling their delinquencies in consumer loans, even while most consumer loans are seeing default rates rise. The bank is bucking the trend. I believe this is the sign of exceptional management.
Bottom Line
Heading into earnings on July 16th, I believe Bank of America stands out. Leading up to the earnings call, the bank has shown signs of increasing deal flow and a strong effort to return cash to shareholders while maintaining disciplined capital ratios. They seem to be firing on all cylinders.
Of course, with the current economic environment, there are concerns over and loan defaults and how this could affect their balance sheet. However, not only has Bank of America proven they are able to reduce default rates, interest rates have also begun to fall, which should help default rates.
In the next earnings call, I believe we will see more signs showing the now stronger rebound of their investment banking and capital markets sectors. If this proves true, I believe Bank of America will be well set up to continue delivering strong financial performance. With this, I now believe Bank of America is a strong buy.
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