The Bull Case For Bank of America

The Bank of America Corporation (BAC) recently surprised the market by missing its revenue expectations for the second quarter 2021. This in itself was unusual, but for a company whose stability attracted even Warren Buffett enough to become one of its largest shareholders, a miss such as this could have had investors re-examining whether the stock was still the safe bet they had perceived it to be.

Despite this top line miss, the company had a pretty good earnings report. We’ll make the case here for why Bank of America stock is still rated a Buy, and delve a little deeper into some of the hidden growth stories that got buried under the more pessimistic headlines.

Q2: A Rather Good Quarter, Actually

In the wake of news about its current revenue miss, BAC shares fell 5% in reaction to the apparently negative coverage the results received.

Pundits were quick to hone in on the fact that banking corporations rarely come in under top line estimations, and for Bank of America this was particularly unusual; outside of pandemic-era earning seasons, BAC has previously only missed one revenue call since December 2017.

Looking under the hood, this revenue miss was easily explained. BAC has a large investing banking business – it ranks third globally for investment banking fees – and it was here that revenues really suffered.

The problem for Bank of America was that, before this quarter, market sentiment was volatile, which meant that investors were putting their money into fixed-income securities. However, Q2 was one of the least volatile periods since the beginning of the pandemic, and customers were just not trading like they were before.

In fact, the shortfall in fixed-income spending was to the tune of $700 million. Given that BAC only missed revenues by around $200 million, you can see that the bulk of this miss can be chalked up purely on the poor performance of this one segment.

Despite the miss on revenue, Bank of America easily met earnings predictions with an EPS of $1.03 versus a consensus figure of $0.76. This was up $0.86 sequentially from the first quarter, and $0.37 the same time a year-ago.

Other highlights for the quarter included a resumption in loan growth and an increase in deposits. While loans were down year-on-year, they were up sequentially from $903 billion in Q1 to $919 billion for Q2.

Equities trading made up for drops in its consumer business, although daily loan balances in Q2 saw growth in both consumer and commercial sectors. Deposits grew to $1.89 trillion, up 14% year-on-year. Bank of America’s Chief Executive Officer, Brian Moynihan, believes that the company is now at a “loan growth inflection” point.

Non-interest income was down 2% year-on-year to $11.2 billion, but revenues appear to be gaining traction again, as the first-half year-on-year numbers were up from $22.1 billion to $23.9 billion. Non-Interest Expense also dropped sequentially from $0.5 billion in Q2 to $15.0 billion, although Q1 does normally see higher seasonal payroll costs, and expenses on a quarterly comparison rose 12% to $15.0 billion.

Crucially, net income estimates of $6.6 billion were smashed by almost 40%, with an actual figure of $9.2 billion helping contribute towards BAC’s EPS beat. 

Finally, although the low interest rate environment hit the bank’s fixed income wings, its trading desks outperformed analyst expectations by some way. BAC’s Global Wealth and Investment Management had a record client balance of $3.7 trillion, up 25%, and an overall net income of $991 million. The Global Banking business was also close to record levels too, with deposits of $507 billion up 3%, with a net income of $2.4 billion.

A Bonus For Investors

Attesting to the success of the latest quarter, Bank of America is undertaking measures to return value to shareholders. First, the company announced a $25 billion share repurchase program, worth around 7% of the bank’s current diluted outstanding stock. Furthermore, BAC has also declared a 17% dividend increase, which will come into force in the third quarter.

This isn’t just a nice cash bonanza for current investors – it’s also a sign to potential buyers that the company is in a sound position going forward.

A big part of BAC’s optimism is likely down to tailwinds from the growing economic recovery, with consumer spending in the wider market filtering down onto the bank’s own balance sheet. Indeed, the average BAC customer is spending 22% more than before the pandemic, and that’s likely to continue and possibly grow as confidence returns.

Two one-off provisions this quarter also helped the bank: a positive tax adjustment of $2.0 billion from a revaluation of its UK assets resulted in a net benefit of $1.2 billion; and a release of credit reserves added $1.6 billion to earnings.

The company had been building up its cash stockpile to protect itself from a wave of customer defaults arising from the Covid pandemic, but fiscal intervention from government averted those defaults, and BAC could liquidate the reserves for the benefit of shareholders instead. 

Some Lingering Issues

It would be wrong to paint BAC’s current position as anything but good; there were a few points of interest that might concern investors.

First, net interest income (NII) has been flat since Q3 2020 at around $10.34 billion. Before this, NII was hovering around the +$12 billion mark, a good 16% on current values. Bank of America (BAC) predicted this scenario its Q3 2020 earnings call, with management saying that they believe Q3 will be the bottom for NII, and are optimistic about it moving higher during 2021.

However, it its latest Q2 conference call, BAC had to backtrack somewhat. Alluding to further comments made last quarter predicting a Q4 NII increase of at least $1 billion, Chief Financial Officer Paul Donofrio warned that, although the $1 billion uptick was still possible, the decline in long-end rates posed a serious challenge to this eventually happening.

While not entirely a dire outlook, the revised guidance isn’t especially pleasing.

Second, the bank’s net interest margin contracted to 1.61%, less than what analysts were hoping for, and 26 bps off of last year’s number. Again, not too much to worry about, but something to keep in mind nonetheless.

The Bull Case For BAC: Conclusion

Bank of America remains a solid banking play despite its revenue miss and slightly declining margins. Secular tailwinds from the economic recovery will drive consumer lending again, and its trading desks are already racking up record quarterly results as we speak.

The stock is currently valued higher than at any time during 2020, and it appears that the damage from the Covid-19 pandemic is finally over. If the company maintains the momentum it gathered during this quarter, expect share price levels to keep on rising.

---

The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.