Warren Buffett is clearly a fan of bank stocks, but there's one that has been his obvious favorite in recent years. After acquiring a position in Bank of America (BAC 3.35%) as a result of a particularly savvy financial crisis-era investment, Berkshire Hathaway (BRK.A 1.18%) (BRK.B 1.30%) has continued to put more of its capital into the financial giant. As of the latest information, Berkshire owned more than 1 billion shares of Bank of America, representing a stake of nearly 13%.
Bank of America hasn't exactly been a strong performer recently, with shares underperforming the S&P 500 in 2022 and down 32% from their peak. But despite some justifiable concerns, there's a lot to like about Bank of America, especially after the recent drop.
Why is Bank of America down by more than 30%?
To be sure, there are some good reasons investors may be a little cautious about Bank of America's business right now. We're already starting to see a slowdown in consumer spending due to inflationary pressures, and if the economy falls into a recession, it could get even worse.
Plus, there is a legitimate fear that we could see an uptick in loan defaults as inflation rises if people start having trouble paying their bills.
Does the good outweigh the bad?
Despite the legitimate worries, there are some good reasons to be optimistic about the bank's future.
For one thing, Bank of America could end up being a big beneficiary of the rising-rate environment. It has a high proportion of deposits that pay little or no interest, and net interest income increased by 22% year over year in the second quarter. The bank's net interest margin grew from 1.69% in the first quarter to 1.86% in the second.
Management estimates that a one-percentage-point increase in the overall yield curve would result in a $5 billion annual increase in interest income, and with the Federal Reserve expected to continue raising rates, we could see this increase -- or more -- reflected in the numbers within the next few quarters.
Plus, the bank's recent growth is strong. Loans grew by 12% year over year in the second quarter and grew about 4% sequentially. Bank of America also continues to return capital, both through its dividend and buybacks. In fact, the bank repurchased more than 5% of its outstanding shares over the past year alone.
It's also worth mentioning that while Bank of America saw its nonperforming loan rate skyrocket to 3.75% in the 2008-2009 recession, this is a very different bank today. For example, home equity loans have declined from over 15% of the bank's loans at the end of 2009 to less than 3% today, and credit standards are much tighter. Credit card balances are also about half of what they were back then.
So, even in a deep recession, there's reason to believe Bank of America's business won't suffer nearly as much as it did then. And the net charge-off rate in the second quarter was a historically low 0.23% of loans on an annualized basis.
Is Bank of America a buy now?
To sum it up, Bank of America isn't down for no reason. There are legitimate fears of a slowdown in consumer spending and an uptick in loan defaults that investors should definitely keep in mind.
However, the headwinds seem to be priced into the bank stock and then some at this point. Plus, there are some positive catalysts that should keep the bank's profits strong. While Bank of America could certainly take investors on a roller coaster ride in the near term, patient investors may want to take a closer look after the recent decline.
