Bank Of America: Doing OK, But Do You Want To Invest In It?

About: Bank of America Corporation (BAC)
by: John M. Mason

Bank of America has posted some pretty good numbers in the first quarter of 2019, but investors don't really seem turned on by the bank as an investment opportunity.

The current performance appears to have been driven by interest rate increases and continued consumer borrowing, something that may stop if the Fed begins to lower rates.

The future vision of the bank seems to be connected with continuing consumer strength, consumer digital technology, and building financial centers - a different model than other large banks are following.

Aaron Back writes in the Wall Street Journal “Bank of America (BAC) has been one of the biggest beneficiaries of rising interest rates over the past few years.”

Paul Donofrio, Bank of America’s Chief Financial Officer agrees: “It’s a good economy.”

Mr. Back now argues, however, that “Now that tailwind is gone.”

Bank of America reported Tuesday evening that its net profit rose by $7.3 billion, or 6 percent, in the first quarter, beating analysts' expectations.

Yet, the bank’s share price, although it fell by more than 2 percent in the morning, closed today roughly where it closed yesterday.

“A few words from Chief Financial Officer Paul Donofrio told investors all they needed to know. Net interest income rose 6% last year on a combination of higher rates and around 3% gross domestic product growth in the U.S., he said. This year, with the Federal Reserve on pause, rate expectations pared back and GDP growth slowing, net interest income will likely rise only around 3%, he said.”

It seems as if Bank of America has benefitted as much from Federal Reserve policy in recent years, and not only because the Fed has been raising interest rates. For one thing, Bank of America is a strong lender to consumers. Part of the Federal Reserve’s strategy during the current recovery has been to generate a sufficient wealth effect in the economy so that consumer spending can be stimulated and help drive economic growth.

This is exactly what has happened.

And the rise in interest rates in the past couple of years has played right into this plan.

Up until a year ago or so, interest rates were still low enough that the net interest margin commercial banks could earn was very low. The rising interest rates have had the effect of widening BofA’s net interest margin, especially since many consumer loans have slightly longer maturities than commercial loans and can take advantage of a rising yield curve.

The performance of Bank of America over the past couple of years indicates that this is exactly what occurred. This is why Mr. Back warns of what could take place if interest rates level off or, especially, if they begin to decline. Bank of America’s “tailwind” might be gone.

BofA’s CFO Paul Donofrio argued that “Net interest income will also likely decline in the second quarter.” He added that “This is partly because lower long-term rates are driving early prepayment of mortgages and mortgage-backed securities. Interest income should then start growing again in the second half, he said, depending, of course, on global economic conditions.”

Mr. Donofrio concluded, “If conditions get worse and the Fed edges toward easing, all bets would be off.”

But when Mr. Donofrio was asked if he is considering steps to limit the bank's sensitivity to interest rates, he didn’t rule it out. However, he indicated that this move is highly unlikely.

Thus, Mr. Back concludes that BofA’s stock price volatility will probably remain until interest rates actually stabilize.

Overall, Bank of America posted some fairly admirable numbers. For example, the first-quarter return on shareholders’ equity rose to 11.6 percent. This puts it right in the performance mix of all the six other largest banks in the United States.

It has taken Bank of America some time to get to this level of performance, but when Brian Moynihan became the bank’s Chief Executive Officer in 2010, the organization was actually losing money. The first full year Mr. Moynihan was the CEO, Bank of America earned less than a 1.0 percent return on shareholders’ equity.

Even though I have not been much of a fan of Mr. Moynihan, Bank of America has seen its return on shareholder equity increase steadily during the economic recovery, but only coming close to a 10.0 percent return in 2018.

Mr. Moynihan continues to focus on building the major consumer bank in the United States. This is particularly noticeable in three areas: controlling costs, adding on financial centers and becoming an industry leader in technology, especially in the retail space.

First, Bank of America experienced a 4.0 percent decline in overhead costs year over year. This performance continues Mr. Moynihan’s emphasis upon achieving and then maintaining industry standards in terms of a low infrastructure cost. He has seen good results in this area year after year.

Second, Mr. Moynihan has announced that BofA will establish 350 new financial centers in new and existing markets by 2021. He contends that more than 90 percent of the US population will have access Bank of America facilities.

Third, he wants the bank to be a technology leader for the retail customer. Digital sales are more than one quarter of consumer banking revenue, and several organizations have declared Bank of America to be “Best in Class” in terms of mobile banking.

Finally, Mr. Moynihan has seen to it that Bank of America is also a leader in stock buybacks. In the first quarter of 2019, the bank repurchased 6.3 billion of its stock.

Given all of this activity, BAC stock price closed right around $30.00. One year ago, the stock price closed right around $30.00.

Investors do not seem to be overwhelmed with what Mr. Moynihan is doing, nor what his vision is for the future of Bank of America. This is consistent with the attitude I have with respect to BofA as an investment. I just don’t have a real good feeling about Mr. Moynihan or his ability to turn the bank into an industry leader. I felt this way in 2012, and I still feel this way today.

There are other large banks I would rather invest in.

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.