If you are looking at the banking sector, the name Bank of America (BAC +0.71%) has almost certainly crossed your mind. It is up there with Citigroup and Wells Fargo when it comes to brand recognition and size. But you should probably step back and consider these three facts before you pull the trigger on Bank of America.
1. Bank of America is not a simple company to understand
The traditional banking business isn't all that complex. A bank takes in deposits from customers and then uses that cash to support its lending activities, often in the form of mortgages. The bank earns the difference between the interest it pays on deposits and the interest it charges for loans. Very few banks are as simple as that, but some focus heavily on being traditional lenders. Bank of America is not one of those banks.
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This isn't meant to be a slight against Bank of America in any way. However, as an investor, you need to know that this is a bigger-than-a-breadbox situation. When reporting earnings, the company highlights four main divisions: consumer banking, global wealth and investment management, global banking, and global markets. Without getting into the details of each division, it should be pretty clear that Bank of America is doing a lot more than the simple banking model outlined above.
If you buy Bank of America stock, you need to be prepared to dig in a little to understand the nuances of each division. You'll need to be ready to accept the inherent ups and downs each division will face, noting that they won't all be moving in sync most of the time.
2. Bank of America's dividend is back on an upward path
Banks are often thought of as conservative investments. And if you look at the dividend growth at Bank of America, you could realistically say it seems to fit that bill. To put a number on that, the dividend has been increased annually for a decade.
There's a bit of an oddity when you look at the dividend growth, however. Over the past one- and three-year periods, the dividend has increased at slightly better than a mid-single-digit rate. Over the past decade, the dividend growth was 36%! That should raise an eyebrow or two.
Data source: YCharts.
While Bank of America is a very different company today from what it was during the Great Recession, the financial crisis resulted in a huge dividend cut. Management at the time got caught up in the subprime mortgage lending mess, ultimately costing investors dearly, particularly those relying on the dividend income generated from owning Bank of America stock. Neither the dividend nor the share price are back to where they were before the dividend cut. And plenty of other banks, including some of the largest Canadian banks, didn't cut their dividend.
3. Bank of America is preparing for hard times
Bank of America's stock has fallen about 40% since early 2022. A big reason for that is rising interest rates, which puts pressure on the company's business. That includes having to pay more for deposits, as well as higher rates lowering demand for loans and making it harder for existing borrowers to repay what they owe. This isn't unique to Bank of America, and frankly, that big stock price drop might be why you are interested in the bank in the first place.
Data source: YCharts.
Bank of America is doing what just about every other bank is doing to muddle through this transitional period between low rates and higher rates. (Though the current interest rate level is hardly elevated by historical standards.) One of the bank's approaches is to increase its Tier 1 capital ratio.
To simplify, this percentage basically shows how well a bank is prepared to handle adversity based on how much capital it holds. At the end of the third quarter of 2023, the bank's Tier 1 capital ratio sat at 11.9% (higher percentages are better), up from 11% a year ago. So, clearly, Bank of America is working to steel itself against the negative impacts of higher rates. However, it is not the most fortified bank you can buy -- that would be Toronto-Dominion Bank (TD +1.00%), which has the highest Tier 1 ratio in North America, at 15.2%.
That doesn't mean TD Bank is better than Bank of America, per se. But if you are taking a safety-first approach, you should go in knowing that Bank of America's Tier 1 ratio is better than it was but not the best in the industry.
Bank of America is fine if you know what you are buying
There's no particular reason for investors to avoid Bank of America. However, it isn't a simple company to understand, given the breadth of its business. The dividend history looks good in some respects, but the misstep during the Great Recession shouldn't be forgotten. And while it is bracing for hard times, like other banks, it is not the best prepared bank you can own. These are three potential negatives to consider alongside the positive points around which you are likely building your investment thesis.
