BAC – Bank of America Offers Significant Upside At Current Levels

The current panic in banks is at extreme levels, reminiscent of parts of 2008, 2011, 2016, 2018, and 2020. There are big differences, however, and the panic has opened up immense opportunities for both income and long-term capital gains for the prudent investor with a strong stomach. Bank of America (NYSE:BAC) is one of the finest banking franchises in the world, and the stock is trading at a very attractive price relative to fundamentals. I believe Bank of America easily has 50% upside within a 2-3-year period from current prices.

After the Great Recession, regulators cracked down on the big banks, virtually doubling capital and liquidity ratios. Just as importantly, many of the riskiest aspects of banking that created major losses such as CDOs and subprime mortgage lending have been discontinued by the big banks. We have a very resilient and dynamic system of banks with immense capital and strong earnings power. The current crisis is fear-driven, and it should ultimately subside sooner than later. I do believe that the government increasing FDIC limits to $1MM at least temporarily would go a long way towards stemming the panic. I also think too much attention is being paid to credit default swap prices, which are a very illiquid and easily manipulated market. Just a few big trades can create big swings in price, which creates a doom loop of lower share prices. Healthy banks should take advantage of buying opportunistic dips in their bonds, to show their strength and increase intrinsic value.

Bank of America ended the 4^th quarter of 2022 with $1.926 trillion deposits, $681B of which are non-interest-bearing. These deposits are spread out through Consumer Banking, GWIM, and Global Banking, with the lion’s share from Consumer Banking. Bank of America and other high-quality banks offer a wide variety of products and services. Not everyone can put all their money in T-bills, as companies have to meet payroll, estimated taxes, etc., of which large amounts of liquid cash must be readily available. While bank analysts tend to be rather myopic, not long ago, the major concern for banks was the Fed possibly implementing a zero or subzero interest rate policy as we saw in Europe. Banks have to manage risks, so Bank of America did buy some longer-term securities that offered higher rates than other options at the time, but obviously look far less attractive given the current rate environment. Had rates gone the other way, these securities would have helped hedge that risk, as they would have been higher than what would have been available. These held-for-investment securities have endured mark-to-market losses but ultimately will mature at par. Bank of America ended the 4^th quarter of 2022 with nearly $900B of average global liquidity sources, so a liquidity squeeze like Silicon Valley Bank (SIVB) faced is highly unrealistic. You don’t want a bank to be obsessed with mark-to-market gains or losses on a held-for-investment loan portfolio, as it would dramatically increase the cost of credit, which is the lifeblood of the economy. Banks are in the business of lending and the economy requires a functional and reliable system.

Most credit crises of the past have been credit-driven, such as in 2008. Loose and even fraudulent loan underwriting resulted in humungous credit losses, impairing capital. This crisis is much more of a crisis in confidence. 1930s-style bank runs have taken out some weaker banks with poor business models and risk management. Bank runs can be immensely damaging for any bank, so it likely does make sense for the government to raise FDIC limits temporarily to reduce the damage. Ultimately, FDIC costs would be far higher from continuing bank runs, than actually negating the risk with increased limits, which would halt the panic. Bigger banks such as Bank of America are said to be actually picking up deposits from the smaller banks, so this doesn’t seem like a major issue for BAC, but the contagion risks are what should be minimized for the overall health of the economy. Bank of America’s credit portfolio is pristine with just .26% charge-offs in Q4 2022. BAC has $12.7B, or 1.22% of total loans reserved for loan and lease losses. Nonperforming loans actually declined from Q3 by $.2B, to just $3.8B. 61% of consumer NPLs are contractually current. Commercial reservable criticized utilized exposure of $19.3B increased by $1.6B from Q3, primarily driven by U.S. Commercial and Industrial and Commercial Real Estate. These are very manageable figures, especially when you consider that BAC makes over $30B a year pretax, pre-provision. During the Financial crisis, Commercial net charge-off rates averaged about 1.28%, but are sitting at just .11% currently for BAC. Consumer net charge-off rates averaged 3.6% during the Financial Crisis, but now sit at just .5% as of the 4^th quarter of 2022. Credit card net charge-offs for BAC averaged 8.3% during the Financial Crisis but are now just 1.7%.

BAC ended Q4 with a CET1 ratio of 11.2%. Book and tangible book value per share stood at $30.61 and $21.83, respectively. I’d expect to see all these metrics meaningfully higher at the end of Q1 due to retained earnings and lower bond yields, which should reverse some of those AOCI losses. Bank of America and the other big banks have a wider variety of funding sources, including more long-term debt than their smaller rivals. Average global liquidity sources of $868B are readily available to handle any short-term issues that might arise. Bank of America’s management under Brian Moynihan has always been laser-focused on improving operating leverage, so I fully expect this to continue, and BAC should be able to keep growing earnings. The Merrill Lynch franchise is incredibly strong and along with BAC’s Global Banking unit, could stand to gain some market share from the demise of Credit Suisse (CS).

While market participants seem so focused on higher rates hurting the value of securities portfolios, little attention is paid to the fact that banks have been generating higher pretax, pre-provision income on the back of higher rates. For BAC, 2022 pretax, pre-provision income grew to $33.5B n 2022, up from $29.4B in 2021. Net interest income increased by 29% YoY, or $3.3B in the 4^th quarter, versus the 4^th quarter of 2021. Net income was down a bit as 2021 earnings were bolstered by $6.8B reserve release, versus a $.4B build in 2022. Earnings per share in 2022 were $3.19, down from $3.57 in 2021. BAC produced an ROTCE of 15.1% and a 65% efficiency ratio in 2022. At a recent price of $27.14, BAC trades at just 8.5x TTM earnings and 7.9x forward earnings. This is way too cheap given BAC’s extraordinary credit quality and diversified earnings streams. I believe Bank of America is worth in excess of $40 per share given its resilient earnings power. The fears pushing BAC stock down are based on some fake assumption that they will have to write down their held-for-investment portfolio to market. Keep in mind those AOCI losses will be significantly less after Q1 and nobody seems to clamor for them being marked to market when they are at hugely positive marks. Instead then, the concern is that if the banks would have sold them and taken profits, the new investments to replace them would generate less income. Well, the opposite is occurring now, as the banks are earning more interest income, but the market isn’t willing to give any credit to that. Bank of America’s franchise value is massive, and I expect the bank to be a winner amidst this manic-depressive market environment.