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Why Bank of America Is Down in 2018

By Matthew Frankel, CFP® - Updated Nov 12, 2018 at 8:42AM

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Despite fantastic earnings growth, Bank of America's stock is actually down a bit in 2018 -- here's what investors need to know.

At the beginning of 2018, many investors were excited about what the year held for the banking industry. Tax reform was set to catapult earnings higher, the prospect of banking deregulation was in investors' minds, and rising interest rates were expected to substantially boost profit margins for banks.

However, it's actually been a pretty weak year for the banking industry so far, especially the big banks. The financial sector as a group is down by about 3% since the start of 2018, and Bank of America (BAC 0.72%) is performing right on par with that figure.

Inside of a Bank of America branch.

Image Source: Bank of America.

Bank of America has performed well

To be perfectly clear, Bank of America's business has been doing quite well. Earnings are up by 43% year over year; loans and deposits are up by 3% and 4%, respectively; and Merrill Edge brokerage assets are growing at a double-digit pace.

Bank of America's 57% efficiency ratio is one of the best among the big banks and shows how effective the company's expense-management initiatives have been. And the company's return on equity (ROE) and return on assets (ROA) of 11% and 1.23%, respectively, are much improved as well.

So, the dismal stock performance isn't because of poor performance from the company's business. Rather, there are a few industrywide reasons why banks haven't performed too well in 2018.

Rising rates haven't panned out as hoped

First, banks generally see profit margins expand as interest rates rise. Without getting too deep into the mathematics, the general idea is that the rates banks charge on lending products (credit cards, mortgages, auto loans, etc.) tend to rise faster than the rates they pay out on deposits.

This was an especially exciting prospect for Bank of America investors, as the company has the highest proportion of noninterest-bearing deposits among the big banks. In other words, for this portion of Bank of America's deposit base, any increase in consumer lending rates should be pure profit.

In 2018 so far, the Federal Reserve has hiked interest rates by 75 basis points, but so far that hasn't translated into as much margin expansion as banks had hoped for. In fact, Bank of America's net interest yield has increased by just three basis points since the end of 2017.

Deregulation hasn't affected big banks

A much-anticipated bank deregulation bill passed both the House and Senate and was signed into law in May. However, it didn't do much to help the big banks.

Specifically, the bill changed the asset threshold for being considered a SIFI (systemically important financial institution) from $50 billion to $250 billion. Bank of America has more than $2.3 trillion in assets, so this doesn't provide any relief. The bill also made it easier for small banks to offer nonconforming mortgages and eased data-reporting requirements for these institutions.

In a nutshell, the bill made doing business easier for many U.S. banks -- but Bank of America wasn't one of them.

The benefits of tax reform were priced in before 2018 began

Finally, it's obvious from the bank's earnings reports this year that Bank of America was a big beneficiary of tax reform. In the third quarter, earnings grew by 43% year over year as I mentioned earlier, but revenue increased by just 4%. Some of this difference was due to the bank's efficiency improvements, but most of the earnings boost was fueled by the lower corporate tax rate.

However, it's important to realize that the benefits of tax reform were already reflected in the price of the stock when 2018 began. Between the post-election rally in 2016 (which was partially in anticipation of tax reform) and then the big rally in late 2017 when the Tax Cuts and Jobs Act was being hammered out and ultimately passed, it's fair to say that the 2018 benefits of tax reform weren't actually a surprise to investors.

The bottom line

If you just glance at Bank of America's earnings growth and other key business metrics, you may expect to see that the stock has soared in 2018. However, that simply hasn't been the case.

Bank of America, along with many bank stocks, performed extremely well in 2016 and 2017. In fact, the bank's stock rose by more than 75% over that two-year stretch. As a result, it's likely that a lot of the positive catalysts helping the bank's business, such as tax reform, economic growth, and the generally business-friendly climate, were already priced into the stock before 2018 began.

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