Just looking at the headline numbers, Bank of America (BAC 1.70%) certainly had a very strong quarter.
The second-largest bank in the U.S. by assets generated diluted earnings per share of $0.94 on total revenue of $26.3 billion, which amounted to a 12.5% return on equity. Both earnings and revenue easily beat analysts' estimates.
Although it was certainly a strong performance amid a challenging environment, not everything in the bank's earnings report was so great. Here's the most disappointing part of Bank of America's quarter.
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Deposit trends
Heading into this quarter, investors were very focused on deposits -- specifically, deposit flows and deposit costs. That's because there were a pair of large bank failures in the first quarter, driven by deposit runs. Furthermore, risk-free, short-term U.S. Treasury bills and certain bank account products are now yielding an attractive 4% to 5%.
The largest money-center banks were seen as safe havens in the first quarter because the U.S. government won't allow these giant to fail due to their size, complex interconnections and importance to the global financial system.
While the large banks did provide refuge to nervous customers, I was disappointed by the deposit trends at Bank of America during Q1. Average deposits fell 2%, while period-end deposits declined slightly as well. That differs from Bank of America's peers, who saw intraquarter deposit inflows due to the banking crisis, when customers started to rush to the large banks.
At JPMorgan Chase (JPM 1.44%), average deposits fell 3% but period-end deposits were up 2%. At Citigroup (C 2.82%), average deposits rose slightly from the sequential quarter, although period-end deposits slumped 3%. However, Citigroup Chief Financial Officer Mark Mason said some of the outflows were due to tax seasonality and that flows did reverse in March when the banking crisis started. Wells Fargo (WFC -0.26%) also struggled more than its peers, seeing a 2% drop in deposits on an average and period-end basis.
Management at Bank of America did not disclose how many deposit inflows it saw as a result of the banking crisis, but CFO Alastair Borthwick noted on the earnings call, "We're pretty confident we saw noticeable flight to safety." JPMorgan Chase had roughly $50 billion of inflows, while Citigroup saw about $30 billion.
The deposit performance also translated into lower net interest income (NII), which is the money banks make on loans and securities after funding those assets with liabilities such as deposits. Bank of America's NII fell about 1.6% in the quarter. That compares less favorably to Wells Fargo's 1% drop in NII, Citigroup's 1% increase, and JPMorgan's 3% gain.
A near-term problem
Unfortunately, Bank of America is likely a victim of its own success. It has historically had the strongest deposit base of its peers, which means more zero-interest, sticky deposits. But with interest rates rising so quickly, these customers are proving more sensitive to rates because the opportunity to earn 4% or 5% of yield in a short time period is very attractive compared to the opportunities available during the past decade.
Borthwick said that he expects Bank of America's NII to fall again next quarter due to continued deposit pressure. But the Federal Reserve is likely nearing the end of its rate-hiking cycle soon, which should ease some of the pressure on deposit repricing if and when it eventually happens.
I suspect that Bank of America's deposit base will continue to be a source of strength on a long-term basis and I believe this is actually a good time to buy the stock, while it trades at a cheap valuation. But in the near term, the current pressure may lead to underperformance at Bank of America compared to its peers.
