It's safe to say that Bank of America (BAC -0.13%), the second-largest bank by assets in the U.S., is a completely different bank than it was after the Great Recession, when shares fell below $4. Chief Executive Officer Brian Moynihan has done an excellent job of turning the bank around and building a much more durable operation with much stronger earnings power. Toward the end of 2021, Bank of America traded at its highest stock price since 2007, at more than $49 per share, albeit it was a period when most stocks traded at elevated valuations. Since then, its stock has fallen back to roughly $34 per share. Let's take a look at where Bank of America could be at the end of 2023, in a little less than a year and a half.
Stronger earnings coming
The good news is stronger earnings are almost certainly on the way. Bank of America is one of the largest beneficiaries of rising interest rates, which the Federal Reserve has rapidly hiked this year and will likely continue to do as the year progresses.
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In the second quarter, Bank of America increased net interest income (NII) -- the profit banks make on loans, securities, and cash after funding those assets, and one of the main sources of revenue for banks -- by about 7% from the first quarter of the year. But management expects to see as much as an additional $1 billion of NII in Q3 and then for NII to grow at an even faster clip in Q4. It's not outside the realm of possibility that Bank of America could exit Q4 with a run rate of $15 billion quarterly NII, which would be 50% more than the bank generated in the second quarter of 2021.
Now, there is the possibility of a recession in the near future, which could cut into loan growth or even lead the Fed to cut interest rates, but Bank of America's investment banking division is also operating at a very low level right now, so that could pick up. Headwinds could come from normalizing trading revenue and higher credit costs, but all in all I feel fairly good about the bank's earnings outlook between now and 2023.
Wall Street does, too, apparently. Analysts on average expect the bank to make $3.20 per share this year and then ramp up to $3.76 per share in 2023. It's hard to know what kind of recession these analysts are baking into their models, but Bank of America could earn $4 per share in 2023 if the economy avoids a severe recession.
Building capital will be a headwind
All banks must hold a certain amount of capital to be prepared for unexpected loan and trading losses should an adverse economic scenario occur. The Fed's recent stress tests resulted in many large banks having higher regulatory capital requirements, despite the fact that all of the 33 banks put through stress tests passed.
So now Bank of America is going to have to build capital to meet new requirements at the end of this year, and management is also expecting even higher regulatory requirements in 2024 due to a special surcharge for being a global systemically important bank.
Changing and rising regulatory capital requirements are nothing new for banks since the Great Recession, but the overall takeaway is that building capital will leave Bank of America with less spare capital to conduct share repurchases at the same level as it would have been able to. Management expects there to be some room, but it's likely not going to be what it has in the past. However, the capital rules and requirements for the largest banks change so often in a year that it could be a new situation by this time next year. For now, though, it seems like higher capital returns and less potential for repurchases are weighing on investors' interest in Bank of America.
Where will the stock trade at the end of 2023?
Ultimately, I expect Bank of America's earnings to get much better in the back half of this year and in 2023. The bank should also have the ability to build the capital it needs to get into regulatory compliance while repurchasing a modest amount of stock.
If the economy avoids a recession and Bank of America can generate roughly $4 of earnings per share, then I think there is significant upside from here. Since 2016, the bank has traded at an earnings multiple anywhere from between 10 and roughly 20, giving it a midpoint of about 15.
Banks also trade in relation to their tangible book value or net worth. Since 2016, Bank of America has traded from just 90% of its tangible book value to a high of roughly 215%. But for the most part, it has traded around 160% of tangible book value. I think a higher valuation of at least 170% is fair, because the stock has spent more time with an elevated valuation since 2016, given how much its business has improved and how it will benefit from rising rates.
At a 15 times earnings multiple, that gives Bank of America a $60-per-share target. At 170% price to tangible book, that gives it a roughly $36 price target based on its current tangible book value per share of $21.13.
I am going to settle somewhere in the middle here because Bank of America's tangible book value per share should grow between now and the end of 2023. It also could trade at a higher valuation if interest rates stay at a decent level and a recession doesn't kill loan growth and significantly increase loan losses. Meanwhile, $60 per share might be aggressive if, say, the Fed cuts rates next year and $4 of earnings isn't sustainable after 2023. That's why I like a target of roughly $50 per share, which suggests plenty of upside from here.
