This hasn't been an easy year for Bank of America (BAC -1.78%). The stock is down over 10% year to date, which doesn't compare favorably to the broader market's roughly 8% gain.
Like most bank stocks, Bank of America shares have been sold off in a reaction to a series of recent crises that led to some noteworthy regional bank failures. However, investors have been more worried about Bank of America than its giant bank peers due to the relatively large amount of unrealized bond losses it has on its balance sheet.
While Bank of America does face near-term challenges, I do not view it to be in any danger and believe it will be just fine in the long term.
A rock-solid deposit base
The main problem that led to the downfall of multiple large banks in March is that deposits have been leaving the banking system, and the banks that failed held billions of dollars worth of bonds trading at steep losses that they would have had to liquidate to cover deposit outflows. After this threat came to fruition for a few banks, investors began to parse bank balance sheets carefully.
Bank of America has a large amount of unrealized bond losses on its books -- losses that would wipe out a significant amount of its tangible common equity if significant deposit outflows ever left it compelled to sell those bonds at inopportune times. However, the odds of a bank run of that magnitude happening to Bank of America are practically zero given the diverse and long-tenured nature of its deposit base, which management detailed in its latest earnings presentation.
Image source: Getty Images.
The key point to note here is that the bank has more than $1 trillion worth of consumer and small business deposits, which are stickier, and come from accounts that by nature have smaller balances. As such, most of these are fully insured by the Federal Deposit Insurance Corporation. Pair that robust consumer franchise with the bank's geographically and business-diverse global banking and wealth management units, and you can see why Bank of America has one of the elite deposit franchises in the industry.
I was disappointed by some of the bank's deposit outflows in the first quarter, but I actually think this is likely because of the bank's success in building a sticky, low-cost deposit base. With interest rates moving up so quickly, it has become difficult for consumers and businesses to ignore that more attractive rates are available elsewhere, so I feel like Bank of America has in a way been a victim of its own success over the years.
But overall, because Bank of America does business with clients all over the world and in many industries, has worked with most of its clients for several years, and has multi-product relationships with many of them, its deposit base is rock solid, which should give the bank the capacity to navigate through these near-term headwinds.
Starting to remix the balance sheet
In the first quarter, Bank of America took further action to bolster its balance sheet and liquidity. The bank reduced its securities book by about $66 billion and increased its cash and cash equivalents from $230 billion to $376 billion.
Furthermore, interest rates on certain U.S. Treasuries declined in Q1, which helped reduce the unrealized losses in its bond book as well. Unrealized losses on bonds that Bank of America intends to hold to maturity declined by about $9.5 billion.
Because management is confident in its deposit base, it does not see the need to take any significant action on its bond book because the losses will be recouped, or at least reduced, as those bonds mature, and when the Fed eventually stops hiking the benchmark federal funds rate.
"We're taking the portfolio and we're just making it smaller, it's run off now six quarters in a row," CFO Alastair Borthwick said on Bank of America's recent earnings call. "We're taking all of that and flowing it into cash and loans. That's what we've been doing. We'll just continue doing that, and the portfolio is going to get smaller and shorter over time."
A good time to get in
Bank of America is likely to face some near-term pressure in earnings. Its total amount of deposits is likely to keep declining, and the cost of those deposits is likely to get more expensive, which will put pressure on the money the bank makes on its interest-earning assets such as loans.
But based on the strength of its deposit base, I see no existential threats to Bank of America, and the second-largest U.S. bank by assets has already established competitive moats in most of its businesses.
Today, it's trading at a ratio of just 139% of its tangible book value -- Bank of America hasn't been on sale at a valuation this low since the early months of the pandemic, so I view this to be a good entry point.
