Bank of America (BAC 0.18%) stock was moving higher on Tuesday after the nation's second-largest bank by assets posted better-than-expected results in its second-quarter earnings report.
Revenue in the quarter rose 3% to $25.2 billion, driven by a 4% increase in net interest income to $14.4 billion, and edging out the consensus at $25.14 billion.
On the bottom line, pre-tax income was down slightly, but lower tax expenses helped drive earnings per share up 11% to $0.90, ahead of estimates at $0.81 per share.
Management also noted that every segment of the business delivered organic growth, as the company opened new checking and credit card accounts. Investment accounts were up, as were small business loans, and it continues to grow its global wealth business.
Meanwhile, the company offered evidence that the biggest risks facing the bank aren't as threatening as they seem. Let's dig a little deeper into the earnings call and look at three quotes that explain why the company is well positioned for the future.
Image source: Bank of America.
1. BofA isn't expecting a recession
Bank of America CEO Brian Moynihan has commented in the past on the prospects for a recession, saying earlier that his research team wasn't predicting one or that it only saw a very little chance of one, but he doubled down on that forecast on Tuesday.
On the earnings call, Moynihan said: "Just a quick note of what we see in the economy. Our team of economists predicts a soft landing, with a trough in the middle of next year. We see that in our customer data, our 37 million checking customers. We see their spending slowing down."
Growth in consumer payment spend has slowed to 4% growth to $3.1 trillion in the first three quarters of 2023, down sharply from a boom in 2021 and 2022, but Moynihan's comments about a soft landing indicate that his bank expects consumer spending to continue to grow with a deceleration until the middle of next year.
By "soft landing," Moynihan means that inflation will continue to fall to the Fed's target of 2% without high interest rates triggering a recession.
That's just a forecast, of course, but it carries some weight coming from one of the nation's largest banks. If true, it makes the stock more appealing, as Bank of America and much of the rest of the banking sector are trading at a discount because of fears of a recession.
Following the third-quarter earnings report, Bank of America's stock trades at a price-to-earnings ratio of less than 8 and offers a 3.6% dividend yield.
2. Higher interest rates are a tailwind
High interest rates have been a mixed bag for banks. On the one hand, higher interest rates allow banks to capture greater net interest income, as higher rates tend to allow for a wider spread between rates on loans and deposits.
On the other hand, higher interest also tamps down demand for loans and tends to act as a headwind on the overall economy, which is bad for banks.
During the call, CFO Alastair Borthwick was asked if the bank would benefit from rates staying where they currently are. He responded: "Well, higher for longer is going to be better. So you're right. We've got the forward curve in our expectations, and if that doesn't turn out to be the case, we'd expect NII (net interest income) would be higher." (By "forward curve," he's referring to the expected decline in the federal funds rate.)
Like the rest of the stock market, Bank of America stock reacted poorly to the Fed's forecast last month that interest rates would stay higher for longer, and the stock fell for five straight sessions in a row, giving up 5%, after last month's Fed meeting.
However, Borthwick now seems to be saying that higher rates would benefit the bank, as it would allow it to collect more net interest income.
Bank of America currently expects net interest income to trough in the fourth quarter of this year at $14 billion and begin to grow again by the middle of next year. By the fourth quarter of next year, it expects NII to grow by low single digits, though that forecast assumes rate cuts in the second half of the year. If those don't materialize, NII should be even stronger.
Based on this statement, Bank of America seems to have neutralized the two biggest risks in front of it -- a recession and high interest rates -- assuming its forecast about a soft landing is correct.
3. BofA is ready for the new capital requirements
Basel III Endgame, the next round of capital requirements for banks, is currently being negotiated and is expected to be rolled out in the coming years.
The new protocol will require lending institutions like Bank of America to hold even more capital on their balance sheets. It's yet another headwind factored into the stock and helps explain why shares are trading at a discount.
That makes sense, as higher required capital ratios will impact returns, but Bank of America expects Basel III to have a more negligible effect than you might think.
Discussing Basel III, Moynihan explained: "Now let's assume the proposed changes going through in full. The proposed changes are phased in from the middle of '25 to '28 under the current proposal. When those are fully phased in, we would have a need for $195 billion of total capital. Now, if you look on the upper right-hand side of the page, you'll see that we're today we're at $194 billion. So we hold the required capital today."
In other words, the company already has enough capital on its balance sheet to satisfy the Basel III rules, as BofA anticipates. Though it would likely need more of a buffer, the requirements aren't as much of a challenge as investors might think.
Why the stock is a buy
Bank of America addressed what appears to be the three biggest risks facing the company on the call -- the chances of a recession, sustained high interest rates, and the new Basel III requirements -- and explained why they are not really headwinds.
Nonetheless, investors are still treating the stock like it's facing significant risks. As you can see from the chart, it's the cheapest it's been in a decade, except for a brief dip during the pandemic.
Investors understandably have some anxiety about the economy today, but if Bank of America is right about the soft landing, the stock could rerate to a P/E around 12, about its recent historical average, by this time next year, giving the stock at least a 50% upside.
So if you believe management, there's less to fear in Bank of America stock than the market seems to think.
