Bank of America: A $106 Billion Hole Isn't A Problem Until The Fed Says It Is

The Big Bank Investment Thesis Remains Robust In BAC

We previously covered Bank of America (NYSE:BAC) in April, discussing its FQ1'23 performance after the banking crisis in March 2023. Interestingly, it had reported declining deposits QoQ and YoY, with much of the money likely flowing to money market funds at $5.45T by June 12, 2023 (+30.6% YoY).

At that time, we remained optimistic about the bank's improving Net Interest Income [NII], thanks to the Fed's sustained hike since March 2022. Its provision for losses appeared to be decent as well, compared to pre-pandemic levels, attributed to the strict FICO scores of over 770 across its loans.

Therefore, we had iterated our Buy rating, since BAC had been well positioned to weather the short-term volatilities.

BAC's Improved Profitability, Thanks To The Rising Interest Rates

For now, BAC has delivered another impressive quarter in FQ2'23, with revenues of $25.2B (-4% QoQ/ +11% YoY) and GAAP EPS of $0.88 (-6.3% QoQ/ +20.5% YoY).

Most of the profitability outperformance is attributed to the drastic expansion in its FTE NII to $14.3B (-2% QoQ/ +14.4% YoY) and FTE Net Interest Yield to 2.65% (-0.2 points QoQ/ +0.45 YoY) in the latest quarter, partly attributed to the expansion in the bank's interest bearing deposits to $1.27T (+1.1% QoQ/ +4.5% YoY).

Therefore, investors need not be concerned about BAC's liquidity as well, despite the notable downward trend in the total deposit growth, especially since it continues to grow its Global Liquidity Sources to $867B (+1.5% QoQ/ -11.8% YoY) in FQ2'23.

Therefore, while it may still report $106B of unrealized losses (+2.9% QoQ/ +21.5% YoY) in the latest quarter, it is apparent that the Fed is not overly worried for now, thanks to the robust liquidity, its safe haven status, and depositors' confidence in the bank.

Thanks to the higher treasury yields, BAC also reported higher trading activities, triggering the expansion in its sales/ trading revenues to $4.38B (-13.2% QoQ/ +9.7% YoY) in FQ2'23.

While keen eyed investors may be temporarily concerned about the bank's QoQ moderation, this cadence is mostly attributed to the market fears about the US debt ceiling then, as similarly observed by Citigroup (C).

With market sentiments already normalizing, we believe trading/ investments activities may return to the normal cadence in H2'23, potentially boosting BAC's non-interest income from the $11.03B (-6.6% QoQ/ +7.7% YoY) reported in the latest quarter.

Nonetheless, BAC still can not escape from the uncertain macroeconomic outlook, since its net charge-offs expanded to $869M (+7.6% QoQ/ +52.1% YoY) with a ratio of 0.33% in FQ2'23 (+0.1 points YoY), compared to FY2022 averages of 0.21% while nearing FY2019 averages of 0.38%.

This is mostly attributed to the bank's higher credit card losses, with the total US debt hitting $993.51B at the time of writing (+11.7% YoY). Then again, investors need not fret, since the reported delinquency rate of 2.43% in Q1'23 (+0.18 points QoQ/ +0.76 YoY) remains below the 2019 average of 2.58%.

However, with Powell guiding at least two more rate hikes in 2023, there is a growing risk that the delinquency rates may exceed pre-pandemic averages.

Therefore, while the rising interest rate environment may have been a net positive for banks in general, including BAC, attributed to the expanding NII and NIM, investors may want to pay close attention here, due to the acceleration in the credit card account adds of 1.2M (-7.6% QoQ/ +20% YoY) in the latest quarter.

Then again, with a stable ROTCE performance of 15.5% (-1.9 points QoQ/ inline YoY) in FQ2'23, compared to FY2019 levels of 15.8%, we remain confident about BAC's prospects during the uncertain macroeconomic outlook.

Income investors may remain patient about BAC's careful dividend increases as well, at an annualized sum of $0.88 (+4.7% YoY) in the latest quarter, compared to the FY2019 cadence of $0.72 (+20% YoY), since capital preservation naturally takes priority for now.

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

BAC 5Y EV/Revenue and P/E Valuations

For now, BAC's valuations are still impacted at NTM Price/ Sales of 2.50x and NTM P/E of 9.85x, compared to its 1Y pre-banking crisis mean of 2.89x/ 10.22x and 3Y pre-pandemic mean of 3.00x/ 11.51x, respectively.

Based on this cadence alone, it appears that Mr. Market remains uncertain about the bank's prospects. With a pivot likely to occur only when the rising inflationary pressure is tamped down, the bank's gross unrealized losses in debt securities may remain a headwind in the near term.

Then again, we continue to hold the belief that BAC is "almost" too big to fail, with the Fed similarly invested in the perceived stability of the US banking system. With things seemingly quieting down with the failure of First Republic Bank (OTCPK:FRCB), we may see market sentiments improve moving forward from this correction.

BAC 1Y Stock Price

Combined with the rising support levels from the previous March 2023 bottom, we may see BAC break out of the April 2023 levels to retest its next resistance levels at $33.

Most importantly, the stock continues to trade below its book value per common share of $32.05 (+1.4% QoQ/ +7.2% YoY), suggesting its mild undervaluation, especially compared to the pre-banking-crisis stock prices of $35s.

While its recovery may be slower due to the uncertain macroeconomic outlook, we remain confident about the bank's long-term prospects, since these headwinds do not last forever.

Therefore, we continue to rate the BAC stock as a Buy here, due to the excellent upside potential to our price target of $40, based on its normalized P/E valuations and the market analysts' FY2025 adj EPS projection of $3.53.

Income investors may also welcome the stock's expanded forward dividend yield of 2.99% due to the steep correction, compared to its 4Y average of 2.35%, though still lagging behind the sector median of 3.80%.