In this continuing series of articles, we've been analyzing how economic fundamentals, Treasury yields, and market events have impacted the stock prices and the profitability of the banking industry.
Prior to the Q1 earnings report for Bank of America Corporation (NYSE:BAC), we analyzed how yields drove net interest income or NII and ultimately earnings. There are a myriad of factors that drive the stock price, but in this analysis, we'll look at how Bank of America (BofA) performed in Q1 versus expectations and Q4.
Also, we'll look forward and attempt to ascertain if yields and economic conditions are favorable for NII and Bank of America.
This analysis also applies to JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC) and Bank ETFs like the FinancialSelect Sector SPDR ETF (XLF) and SPDR S&P Bank ETF (KBE).
In full disclosure, this article is not a comprehensive analysis of Bank of America. I am not a financial advisor, and we will only be analyzing a few of the many factors that drive the stock price and profitability of BAC. Before making any investment decision, please contact your financial advisor and past performance does not guarantee future results.
If you recall from January, Mr. Donofrio forecasted a $600M NII jump in Q1.
From my prior article: (March 28, 2017)
BofA is expecting a Q1 boost of $600 million, according to Mr. Donofrio, the CFO, pushing net interest income to approximately $11 billion:
"Net interest income is expected to increase by about $600 million in the first quarter, Chief Financial Officer Paul Donofrio said Friday on conference call with analysts, helped by the Federal Reserve's quarter-point rate hike in December."
- Source: Bloomberg
Q1 results were better than expected coming in at $11.1B or $700 million for the quarter. And in the earnings report, yields were cited as the chief driver for higher NII.
"Increase reflects the benefit from higher interest rates." - BofA 8K filing.
Analysis of Treasury yields for Q4 and Q1:
Quick analysis of the average 10-year Treasury yield:
|Avg. 10-year yield Q4 2016 and Q1 2017|
|Prior to November 8th||1.78%|
|Avg. 10-year yield- All of Q4||2.14%|
|Avg. 10-year yield - Q1 (as of 03/28)||2.45%|
We can see from the table that the higher average 10-year yield for Q1 helped drive NII for BofA.
Review of net interest income (for those new to these articles):
As interest rates rise, banks charge higher rates on their loans, and the difference between the rate they pay investors for their deposits and the rate they charge for lending money shows up in their financials as net interest income. As yields rise, banks can get away with charging higher rates on their loans, thus increasing their net interest income.
Q1 results analysis:
Here's the Net Interest Income portion from the Q1 2017 earnings report for BofA.
Comparing BofA's results to the competition:
BofA's numbers are impressive particularly when we look at the percentage gain of 20% in NII in just one year.
BAC Net Interest Income (Quarterly) data by YCharts
BofA's 20% NII growth rate looks even more impressive when compared to JPMorgan Chase & Co. (NYSE:JPM), and Wells Fargo & Co. (NYSE:WFC).
BAC Net Interest Income (Quarterly) data by YCharts
However, there a few key other points that have not gotten much press on the same slide of the investor presentation.
Although the jump in net interest income for Q1 is cited in the slide above, the report also includes expectations for Q2.
"Expect NII to increase in 2Q17, assuming rates remain at current levels and modest growth in loans and deposits."
In short, BofA is expecting and will likely need yields to bounce and stabilize for the remainder of Q2.
Loan growth was also cited as a key driver in the report which is important since higher yields alone does not drive NII for BofA, but rather, both loan growth and higher rates are needed for profits to get a boost.
Current Treasury yield rates:
2 Year Treasury Rate data by YCharts
Another way of showing the above chart is through the yield spread.
The yield spread, or the difference between the 2-year and 10-year yield, has been narrowing in 2017 and has picked up pace since March.
10-2 Year Treasury Yield Spread data by YCharts
Spreads have narrowed in Q2 (between the 2-year and 10-year yield).
Typically, the 2-year yield is driven by the Fed interest rate policy while the 10-year yield is mostly driven by economic growth expectations.
Although the spread has widened recently, the narrowing yield spread is largely due to the 10-year yield coming off its highs as geopolitical risks have increased. As mentioned above, any Fed hike expectation will likely drive the 2-year higher further narrowing spreads in the 10-year yield doesn't bounce back.
However, a large jump in loan growth may partially offset lower yields. In other words, BofA may earn less profit on each loan but book more new loans; thus increasing their overall net interest income.
Also, there are many factors that go into driving earnings for BofA including a few metrics going forward that we did not analyze here, like fixed income trading income, mortgage growth, and deposit growth.
However, the long-term remains optimistic for BofA and the banking sector as long as we see firming economic growth. I believe the economic fundamentals will improve creating, healthy loan demand for banks.
And as long as the Fed stays on their path to higher rates, any pullback in bank stocks like BofA should be a buying opportunity provided we see a definite bottom followed by a couple of bounces to the upside. I'm not sure if we've already missed the bottom in the BofA pullback, but we probably won't know for sure until after the Fed meeting in June.
More articles to follow analyzing Bank of America, financials, the Fed, and Treasury yields in the coming days and weeks.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.