It hasn't been a great year so far for the banking sector. It never is when interest rates are high and borrowers start running into trouble. Through a confluence of forces, this year's economic challenges have led earlier this years to the collapse of three banks and rising concerns of more collapses. Although it looks like the upheaval has eased for now, the forces that caused so much damage remain.
Large banks are better fortified their smaller rivals, and Bank of America (BAC -0.21%), the second-largest bank in the U.S., appears to be healthy. However, it's still under pressure. What will it look like at this time next year?
How Bank of America is facing economic challenges
Bank performance typically mirrors the state of the economy. Each bank has variations that affect how it runs, and that make it more or less risky. But as a group, banks do well when the economy is flourishing and vice versa. When there's more money in the system, there are more deposits, more loans, and more of all the things that banks exist for, earning them more money.
When interest rates increase, as they've been doing for just over a year, that slows down the economy. That's actually the point in the Federal Reserve's campaign of interest rate increases meant to tamp down inflation. People spend less money, earn less, have less to deposit, and reduce borrowing.
Considering all of that, Bank of America is managing very well. Revenue increased 13% over last year in the 2023 first quarter, and earnings per share increased 18%, despite an increase in provisions for loan losses.
It's also susceptible to the problems that led to the recent bank collapses: holding debt securities it bought at low interest rates that is now worth less on its balance sheet because of higher interest rates, meaning that selling those securities would result in a loss. However, it targets consumers who on average have much less money in their personal accounts than Silicon Valley Bank's customers did and who are less likely to make a run on their accounts.
The customer focus is a differentiating feature for BofA, and it makes for a stronger operation in these tough times. Although consumer balances declined $33 billion from last year in the first quarter, BofA added 130,000 new accounts in the quarter. People overall may have less to deposit or need their money out of the bank to pay for necessities right now, but they're also fishing around for the best service and deals under these conditions. That sets BofA up for success when the economy rebounds.
One standout in the quarter was global banking. Net income increased 48% over past year to $2.6 billion, and revenue increased 19%, driven by higher net interest income. That's how banks can benefit from higher interest rates.
Should you buy Bank of America stock?
Bank of America isn't a growth stock, but it has an important place in some portfolios. It's a long-held Buffett stock, and one he's retained while he's sold off other bank stocks.
Buffett likes bank stocks in general because lenders are flush with cash and they're cheap. They also pay dividends, which are attractive for many reasons, providing passive income and demonstrating commitment to shareholders. BofA stock is down 15% this year, and at this price, its dividend yields 3.3%.
How it does next year largely depends on whether the Fed continues to raise interest rates. It has signaled that it will, despite pausing hikes for now. Posting strong performance will be harder in a stalling economy. When the Fed reverses course, money flow should lead to improved results.
Bank of America is a strong company demonstrating healthy progress despite challenges. This looks like a good entry point for new investors seeking a value stock, and shareholders can benefit from a high dividend yield.
