Down 25% YTD, Bank of America Stock Is Pressured By Low Interest Rates

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Bank of America

[Updated 11/13/2020] Bank of America Update

Although Bank of America stock (NYSE: BAC) has gained around 50% since the March bottom, it is still down 26% YTD. Trefis estimates Bank of America’s valuation to be around $29 per share – around 10% above the current market price. The banking giant is one of the largest U.S banks in terms of total assets and is very sensitive to changes in interest rates. In its recently released third-quarter results, Bank of America reported total revenues of $20.34 billion, which underperformed the revenue consensus estimates and is 11% lower than the year-ago period. While the Global Markets segment grew by 11% y-o-y due to a jump in sales & trading revenues and investment banking fees, this growth was more than offset by a 17% drop in consumer banking and a 7% decline in the global wealth & investment management segment driven by lower interest income. The lending industry has been under pressure after the announcement of a zero-rate policy by the Federal Reserve in response to the Covid-19 crisis. It reduces the net interest margin that banks earn by taking in deposits and offering loans.

We expect the Bank of America’s revenues to slightly improve in the coming months, mainly driven by higher consumer spending. It is likely to report $86.7 billion in revenue for FY 2020 – 5% below the year-ago figure. Further, its net income margin is likely to suffer due to significant build-up in provisions for credit losses, reducing the EPS figure to $1.66 for FY 2020. Thereafter, revenues are expected to decline to $85.8 billion in FY2021, mainly driven by a drop in investment banking and sales & trading business. However, the EPS figure is likely to improve to $2.16 due to a favorable decrease in provisions for credit losses. This coupled with the P/E multiple of just above 13x will lead to a valuation of around $29.

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[Updated 07/28/2020] Is Bank of America Stock Attractive?

Bank of America stock (NYSE: BAC) lost more than 49% – dropping from $36 at the end of 2019 to around $18 in late March – then spiked 34% to around $24 now. This implies it’s still 32% lower than the start of the year.

There were two clear reasons for this:  The Covid-19 outbreak and economic slowdown meant that market expectations for 2020 and the near-term consumer demand plunged. This could negatively affect businesses and individuals, impacting their loan repayment capability and exposing Bank of America to sizable loan losses. The multi-billion-dollar Fed stimulus provided a floor, and the stock recovery owes much to that.

But we believe there is more upside to come over the coming months 

Trefis estimates Bank of America’s valuation to be around $29 per share – about 20% above the current market price – based on an upcoming trigger explained below and one risk factor.

The trigger is an improved trajectory for Bank of America’s revenues over the second half of the year. We expect the company to report $86.4 billion in revenues for 2020 – around 5% lower than the figure for 2019. Our forecast stems from our belief that the economy is likely to open up in Q3. Further, the easing of lockdown restrictions in most of the world is likely to help consumer demand, benefiting the overall business scenario. The bank’s Sales & Trading operations have driven positive revenue growth in Q1 and Q2 due to higher trading volumes – increased 31% in the first half of 2020 as compared to the year-ago period. On similar lines, investment banking business saw significant growth in Q2 due to a jump in underwriting deals after the Fed stimulus. This has partially offset the impact of weak revenues in other segments. While we expect the trading income to drop in the subsequent quarters, it is likely to be still higher than the year-ago period. Overall, we see the company reporting an EPS in the range of $1.72 for FY2020.

Thereafter, Bank of America’s revenues are expected to further fall to $86 billion in FY2021, mainly due to a decline in sales & trading revenues. Further, the net income margin is likely to improve as compared to the previous year due to a decline in provisions for credit losses, leading to an EPS of $2.43 for FY2021. 

Finally, how much should the market pay per dollar of Bank of America’s earnings? Well, to earn close to $2.43 per year from a bank, you’d have to deposit about $265 in a savings account today, so about 110x the desired earnings. At Bank of America’s current share price of roughly $24, we are talking about a P/E multiple of just below 10x. And we think a figure closer to 12x will be appropriate.

That said, banking is a risky business right now. Growth looks less promising, and near-term prospects are less than rosy. What’s behind that? 

Bank of America has a huge portfolio of consumer, commercial, and wealth management loans – more than $840 billion in FY 2019. The economic downturn could deteriorate the loan repayment capability of its consumers, exposing the bank to significant loan defaults. In anticipation of this risk, Bank of America has increased its provisions for loan losses from around $1.9 billion in the first half of 2019 to $9.9 billion so far – a 5x jump. If the economic condition worsens, this figure could further increase in the subsequent months. Further, a negative economic outlook will make it expensive for the bank to attract funding, increasing the cost of its operations.

The same trend is visible across Bank of America’s peer – Citigroup. Its revenues are expected to benefit from positive growth in its trading arm and investment banking business in FY2020. However, its margins are likely to suffer due to a build-up in provisions for credit losses in anticipation of bad loans. This would explain why Citigroup’s stock currently has a price of over $52 but looks slated for an EPS of around $6.13 in FY2021 (for a P/E multiple of nearly 10x).

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