On April 14, 2016, Bank of America (NYSE:BAC) reported adjusted EPS of $0.21 for Q1 2016, which was inline with the consensus EPS estimate per Fidelity. For comparison purposes, the bank reported EPS of $0.27 for the same quarter in the prior year.
BofA's impressive Q1 2016 financial results have been downplayed by several analysts due to the fact that the bank's earnings were inline with a low earnings bar, as the earnings estimates have been lowered several times over the past few months. However, I believe that the bank's future looks bright when you actually take a step back and think about the earnings potential of this large financial institution.
There were many takeaways from the Q1 2016 earnings results, and conference call, but I will highlight my top three takeaways.
To start, the bank reported inline earnings results. Yes, the earnings estimates were a lot lower than they were several quarters ago but we all understand that these large U.S. banks are operating in a challenging environment.
Additionally, it is important to note that earnings are indeed trending in the right direction.
(Source: Data obtained from Fidelity and table created by W.G. Investment Research)
The YoY changes in the quarterly adjusted EPS for the past four quarters show the progress that has been made by management since the financial crisis. The Q1 2016 adjusted EPS is ~20% lower than the Q1 2015 figure, but again, this hit to earnings was inline with what the investment world was anticipating.
Thinking ahead, the full-year 2016 earnings estimates will likely need to be adjusted down but this does not change my longer term view of BofA being a bank that has great future earnings potential.
BofA reported impressive operating results for the quarter, but the significant drop in revenue is a concern. BofA reported Q1 2016 total revenue, net of interest expense of $19.7b, which was a YoY decrease of 7% from the $21.2b reported for Q1 2015. However, the lack of top-line revenue growth should have come as no surprise because there are many factors that are currently negatively impacting the way that this bank makes money. The major culprit is the low interest rate environment, which is impacting the net interest income, or NII.
(Source: Q1'16 Earnings Presentation)
The NII FTE basis, and the net interest yield, is lower on both a YoY and QoQ basis. Management still touts the fact that the bank is well positioned to benefit from a rising rate environment (i.e. the earnings presentation disclosed that a +100 bps parallel shift in interest rate yield curve is estimated to benefit BofA's NII by $6b over a 12 month period), but it is impossible to predict exactly when the Fed will raise rates.
I take the view that we are in a rising interest rate environment, but the pace of interest rate increases is a complete guessing game. In my opinion, BofA is worth the wait and long-term shareholders will be rewarded whether the Fed raises rates several times this year or waits until next year to materially raise rates.
The Not So Bad
Now to a topic that I have discussed in great detail over the last few quarters, which is expense management. This is one area that management has control over, as the other headwinds (low interest rate environment, energy exposure, global economy and U.S. recession fears) are factors that management simply has to contend with. In a recent article, I described expense management as a key component for BofA being able to drive earnings growth in the current operating environment. In Q1 2016, the bank did make some progress but, in my mind, it was simply not enough.
BofA reported noninterest expenses of $14.8b for Q1 2016, which was an ~6% (or $1b) YoY decline.
(Source: Q1'16 Earnings Presentation)
The YoY decrease in noninterest expenses is good news, but the bank still has a long way to go to get the above-average, and not in a good way, 75 efficiency ratio closer to the industry average. To take a deeper dive, I used the data above to create a table in order to review the trending of these expenses over the last year.
|Noninterest Expense ($B)||Q1'16||% Chg||% of rev||Q4'15||% Chg||% of rev||Q1'15||% of rev|
|LAS (excl litigation)||$0.7||-13%||3.6%||$0.8||-20%||4.0%||$1.0||4.7%|
|Seasonally elevated payroll tax||$0.3||100%||1.5%||$-||-100%||0.0%||$0.3||1.4%|
|Total Noninterest Expense||$14.8||6%||75.1%||$14.0||-11%||70.7%||$15.8||74.5%|
|Total revenue, net of interest exp||$19.7||-1%||100.0%||$19.8||-7%||100.0%||$21.2||100.0%|
Observations from the table:
- The total noninterest expenses were down by 6% YoY, but the expenses as a percentage of total revenue increased from 74.5% to 75.1% (directly impacted by the hit to revenue).
- BofA has steadily decreased the LAS expenses over the last year, and the $0.7b total LAS expenses are down ~30% YoY.
- The All Other noninterest expenses are down from $13.1b at Q1 2015 to $12.5b at Q1 2016, which is an impressive feat.
There are some good and some bad takeaways when analyzing the noninterest expenses, hence the "Not So Bad", but the quarterly results had no impact to my long-term investment thesis for BofA. Management has some work to do to get the efficiency ratio inline with the better-run banks, but this is already fully priced into the stock.
BofA is a top 2 position in the R.I.P. portfolio, and it is a holding that I value highly. There are some concerns --regulatory concerns, revenue growth story, to name a few-- that adds some significant risk to BofA as a long-term investment, but, in my opinion, these concerns are currently baked into the current stock price. The bank is trading below .9x its Q1 2016 tangible book value of $16.17 and ~10x 2016E earnings (per Yahoo Finance!).
BofA has been trading at a cheap valuation for several years now, so you may ask what will make change this? Simply put, time. The financial crisis and the endless number of legal fines and settlements are still fresh in minds of investors, so it will take time for the sentiment to change for BofA. I do believe that the bank is finally past the material legal fines and settlements related to the crisis, and I would contend that the bank is doing all that it can to change the disconnect between its low valuation and its improving fundamentals, with reporting inline earnings results for Q1 2016 being a good example.
Management is staying the course and slowly transitioning this bank from being the government's piggy bank into a well-run financial institution that will be in a position to reward shareholders for years to come. As such, the more you widen your investment time horizon, the more this bank looks like a great buy at today's price.
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Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.
Disclosure: I am/we are long BAC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.