Bank Of America Q2 Earnings: Strong Credit Profile, Leverage For Higher Rates – Buy (BAC)

justin sullivan

Bank of America (NYSE: BAC) dramatically changed its business profile over the past 13 years as the company began to integrate its Countrywide Financial and Merrill Lynch acquisitions. The company is much more balanced and conservative in its approach, which allows it to generate good returns, without the excessive risk profile of banks before the global financial crisis. This strategy has been validated on numerous occasions, particularly in 2020 where despite an unemployment rate which rose to 15% in 3 months, the bank still managed to post very solid profits. Higher interest rates have a very positive impact on BAC’s net interest income which I believe is not fully reflected at current prices, providing a good opportunity for long-term investors to accumulate stock .

Consumer loans now represent 44% of total loans, down from 67% in 2009. The credit card portfolio is down nearly 50% and the home equity portfolio is down about 80% . In the 4e quarter of 2009, 3.75% of loans were non-performing, compared to only 0.41% in the second quarter of 2022. Land development loans decreased from $5 billion to $200 million, and the secure residential exposure increased from $11 billion to $150 million. Despite a lower risk profile, tangible equity has increased by 52% and BAC has more than 4 times the liquidity.

Despite all these undeniably massive shifts in risk profile, every time there is a macro sniffle, banks sell as if history will repeat itself. Underwriting has been much better this cycle and the big banks have a variety of diverse revenue streams, which can offset weakness in other businesses when difficulties arise. Bank of America’s bread and butter focuses on the real needs of its core customers, instead of just focusing on maximizing revenue. This means providing current accounts, wealth management, buying mortgages, etc., instead of trying to have a number one market share in refinancing for example.

While almost everyone, myself included, seems to be in the recessionary camp, the real data is much more mixed, especially with unemployment hovering around 3.6%. Consumers are still spending money at an aggressive rate, although the mix is ​​shifting more towards travel and entertainment, as opposed to things. Management said the average deposit balance for most cohorts is higher than they were both last quarter, including even increasing from May to June, showing that it is improving. still acts as a current trend and that it is several times better than before the pandemic. Last but not least, there are no signs of deterioration in credit quality.

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Presentation of BAC’s 2nd quarter results

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Presentation Investors BAC Q2

July 18e, BAC reported another quarter of strong results with total revenue, net of interest expense, of $22.7 billion, up 6% year-on-year, resulting in net income of $6.2 billion , or $0.73 per share. Net income declined due to the lack of a $2.2 billion reserve release last year, as well as a $2 billion tax adjustment. Pre-tax, pre-provision income increased $1 billion (15%) year-over-year to $7.4 billion, which is the best indicator of underlying earning power. Bank of America achieved a ROE of 9.9% and a ROTCE of 14.1% in the quarter, down both sequentially and year-on-year, mainly due to the absence of major reserve releases and very weak capital markets. Bank of America released its 4e consecutive quarter of operating leverage, which has been a top priority of their vastly underrated CEO, Brian Moynihan, for many years now.

Net interest income of $12.4 billion was up 22%, or $2.2 billion year-on-year, on higher rates and strong loan growth. Net interest yield excluding Global Markets increased to 2.2% from 1.83% year-on-year and 1.99% in the first quarter. Management signaled that by the end of the year, the quarterly NII run rate could be closer to $15 billion, which bodes exceptionally well for Bank of America’s earning power, as the major portion should fall to net income. Non-interest income decreased $1.0 billion, or 9%, due to lower investment banking fees, mark-to-market losses on leveraged loans and lower service charges. Provision for credit losses of $0.5 billion was up from a profit of $1.6 billion in the same period last year. Net charges actually fell 4% to $571 million, a ratio of just 23 basis points, or about 50% below pre-pandemic levels when credit was still quite strong. 92% of Bank of America’s commercial loan portfolio is either investment grade or secured. Bank of America continues to do a good job of managing expenses, with non-interest expenses growing just $0.2 billion, or 2%, year-on-year, despite taking charge of about 425 million dollars on regulatory issues. This is an impressive performance in this inflationary environment where costs have risen sharply for most competitors.

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Presentation Investors BAC Q2

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Presentation Investors BAC Q2

Loans and leases increased $38 billion sequentially, while deposits decreased $88 billion. While some might worry about declining deposits, it’s important to keep in mind that the global liquidity portfolio is still massively high at nearly $1 billion, down from $576 billion pre-pandemic. Holding too much cash hurts returns, so seeing a little more balance is not a bad thing at all. Consumer loans grew at the fastest quarterly rate in nearly 3 years and the bank added 240,000 new checking accounts during the quarter. Although equities had their worst first half in 5 decades, wealth management revenue surprisingly rose 7% year-over-year and pre-tax margin increased. The division added 5,100 new households and customer balances now stand at $3.8 trillion, providing a high margin and recurring revenue stream that is hard to match. Global Banking grew lending 5% sequentially, or 20% annualized, which is nothing short of exceptional. BAC maintained its No. 3 market share in investment banking, albeit in a very weak quarter for the industry as a whole, due to tight capital markets. Digital growth continued with sales up 20%, which management pointed to as a major reason to maintain spending discipline, despite the inflationary environment.

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Presentation Investors BAC Q2

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Presentation Investors BAC Q2

In a rising rate environment where banks print money on net interest income, the biggest fear would be a recession, leading to high borrowing costs. I really don’t see this as a problem for BAC at this stage, given the characteristics and profile of its loan portfolio. If we see a recession, I don’t think it will be as much of a credit-induced recession as in 2008. CET1 ratio improved to 10.5%, SLR improved at 5.5% and BAC has that $1,000,000 worldwide. sources of liquidity. The company paid $1.7 billion in dividends in the second quarter, while repurchasing $1 billion in common stock. Bank of America ended the second quarter with a tangible book value per share of $21.13 and a book value per share of $29.87. Both are slightly down from last year, mainly due to lower AOCI due to higher rates. BAC management sees NII grow by at least $900 million in Q3 and then even more in Q4, so let’s assume an estimate of $2 billion, which would give the bank a quarterly run rate of just under $15 billion.

At a recent price of $32.26, BAC is trading at just 9.7x forward earnings and 9.2x trailing earnings. This is a very cheap multiple for a business that can easily produce a regular ROTCE in its mid-teens, and with an extremely low risk credit profile, relative to its recurring revenue streams. Mr. Market gives no credence to the impact of higher rates and mostly seems to be heeding downside recession scenarios. I think BAC is worth $45-50 per share because I think the company has ample room to grow pre-tax, pre-provision earnings over the next 3-5 years. Even if we enter a recession, I think this will be just another example of Bank of America easily managing any additional credit reserves while maintaining a very profitable operation. Management has indicated that their base reverse case, they expect unemployment to be at 5% at the end of the year, which seems reasonably conservative to me, barring a major collapse in the 2n/a half of the year. It’s been said that banks are like utilities now with all the regulations, and I don’t disagree with that sentiment, but if that’s true, then valuations should be a bit higher to reflect that profile of lower risk like utilities. The bank pays a 2.6% dividend and can buy back shares opportunistically given its strong capital ratios. Although the stock is not as cheap as Citigroup (C) relative to its intrinsic value, it is still very attractive and has a more balanced and diverse collection of companies. Long-term investors would be wise to take advantage of this pessimism and buy BAC while it remains so downcast.