At first glance, it looks compelling enough. Shares are priced at less than 10 times this year's projected earnings, and analysts expect about the same per-share profits next year. The dividend yield of 3% is pretty attractive as well. Better still, the big bank's bottom line improved to the tune of 19% year over year in the second quarter of this year, thanks to higher interest rates.
But before you plow into Bank of America (BAC -0.19%) based on its basic valuation measures, you might want to reconsider. As the old investing adage reminds us, some stocks are cheap for a reason.
Bank of America's subtle red flags
If you already own a stake in BofA, don't panic. The nation's second-biggest bank (as measured by assets) is hardly doomed.
If you're looking for a name from the banking sector to round out your portfolio, however, Bank of America may not be your best bet right now. It's waved a trio of red flags lately that could hint at future turbulence.
One of these red flags is some recent self-scrutinization of its books that didn't quite jibe with the Federal Reserve's number-crunching. While BofA did pass its recent so-called "stress test" and subsequently upped its quarterly dividend payout from $0.22 to $0.24 per share, the bank also "initiated dialogue with the Federal Reserve to understand differences in Other Comprehensive Income over the 9-quarter stress period between the Federal Reserve's CCAR [Comprehensive Capital Analysis and Review] results and Bank of America's Dodd-Frank Act stress test results."
The bank also disclosed a sizable disparity between its common equity Tier 1 capital ratio for the second quarter, using the standardized approach versus a more advanced approach.
Image source: Bank of America's Q2 2023 Earnings Report.
It may be nothing. Bank accounting is complicated, and in some regards, it's as qualitative as it is quantitative.
But BofA was the only major banking name to report such a disconnect between its own math and the Fed's math (and even its other own math), leaving one to wonder if other balance sheet pitfalls that weren't brought to light by the Dodd-Frank stress test regimen are lurking.
The second worry? Bank of America's balance sheet isn't exactly bouncing back from the first quarter's industrywide liquidity crisis.
In March and April of this year, SVB Financial's Silicon Valley Bank suffered a liquidity crunch that ultimately forced its sale to First Citizens. First Republic hit a similar wall around the same time. This sparked worries that all banks might be in the same troubling boat: Not having access to enough readily marketable shorter-term bonds to cover customer withdrawals, while at the same time sitting on steep, unrealized losses on debt securities that aren't meant to be sold prior to their maturity (but could be liquidated if absolutely necessary).
It wasn't an unmerited concern. Even big BofA was feeling this fiscal pinch. In retrospect, though, most banks weren't as deep in these dire straits as First Republic and Silicon Valley Bank were.
On the other hand, Bank of America isn't exactly pushing through the headwind.
The graphic below illustrates why. The unrealized losses on its held-to-maturity assets that make up the bulk of its total assets continued to lose market value last quarter despite stabilizing interest rates, with unrealized losses on these investments swelling from just under $100 billion to nearly $106 billion. That's despite now owning $10 billion less of them. Some of that decline in value reflects the sheer decline in market value; some of it doesn't. At the same time (although not shown on the image), the bank's more liquid available-for-sale securities also shrank from Q1's figure of $166 billion to just under $136 billion.
Image source: Bank of America's Q2 2023 Earnings Supplement.
The point is, BofA isn't exactly working its way out of the liquidity challenge as quickly or as well as you'd expect.
The third concern? After improving for several quarters, most of Bank of America's equity-based performance ratios took a slight turn for the worse in Q2.
Image source: Bank of America's Q2 2023 Earnings Supplement.
One too many worries to step in now
It's not all bad news. As was noted, the bank's Q2 bottom line improved to the tune of 19%, with higher interest rates driving net interest income higher. Its consumer and corporate banking operations are firing on all cylinders, overcoming weakness on the wealth management and brokerage fronts.
On balance, though, these seemingly small red flags are not so small when combined. They might be hints that Bank of America is on the defensive despite last quarter's respectable profit growth. These red flags may even merely be the result of the bank's sheer size and complexity. Even so, that doesn't change the risk they pose to would-be investors.
None of this is a reason yet to shed your shares if you're currently an owner. If you're mulling a position in BofA stock based solely on its valuation, however, you might want to rethink your plans. This is one of those names that (right now anyway) is cheap for a reason.
