Bank Of America: Worth The Wait

Summary

• Bank of America's stock has significantly underperformed the broader market so far in 2020.
• The bank reported Q3 2020 results that were not well-received by the market. However, I believe that investors will be rewarded for holding onto their BAC shares.
• I'm long Bank of America, and I have no plans to reduce my stake in the near future.

Bank of America's (NYSE:BAC) stock has been under pressure since the company reported Q3 2020 results, which only adds to the already disappointing YTD stock performance.

Data by YCharts

The Q3 2020 operating results were not well-received by the market due to several reasons but, in my opinion, the bank's long-term investment thesis remains intact. Therefore, I think that investors with a time horizon longer than a year or two should seriously consider staying the course with their BAC position. I believe the long-term performance of BAC shares will make holding onto the stock through this environment worth the wait.

The Latest, The Report That Failed To Impress

On October 14, 2020, BofA reported Q3 2020 results that beat on the bottom line but that missed the top-line estimate. The bank reported Q3 2020 EPS of $0.51 (beat by $0.01) on revenue of $20.3B (missed by $580mm), which compares unfavorably to the year-ago quarter.

Source: Q3 2020 Earnings Slides

The highlights:

• Revenue declined by $2.5B (or 11%) YoY, driven largely by lower net interest income.
• Net income was lower by $0.05 (or 9%) YoY, driven by a higher provision for loan losses (along with other COVID-related expenses).
• The provision expense was $1.4B, which is a significant improvement from the previous two quarters ($4.7B and $5.1B in Q1 2020 and Q2 2020, respectively).
• Net interest income declined by $2.1B (or 17%), which is a direct result of the low interest rate environment.

The operating results were largely a mixed bag but investors are currently focusing on two major themes/topics: (1) the potential fallout caused by the global healthcare crisis and (2) the impact of the low interest rate environment. Both are definitely significant risk factors for the bank.

The Potential Fallout

BofA and the other large financial institutions have indeed faced significant headwinds due to the COVID-related downturn but let's also remember that this bank is significantly better capitalized than it was before the Great Financial Crisis.

Source: Q3 2020 Earnings Slides

Plus I believe that the bank has already set aside a materially sufficient amount of capital to weather the COVID-related storm (that is, if things truly bottom out in Q3/Q4 2020 and the economy improves heading into 2021).

Source: Q3 2020 Earnings Slides

There is a reason why BofA set aside another $1.4B (an amount that was lower than expected) as COVID has wrecked serious havoc on the U.S. economy. As such, investors being concerned about the big banks' balance sheets should come as no surprise.

However, looking forward, many (if not the majority of) pundits are calling for a recovery in 2021 if a vaccine is discovered/approved.

So yes, I understand why investors are concerned about BofA's near-term prospects given the potential disruptions that we could be facing over the next few months if the economy has not fully recovered. But let's not forget that Mr. Brian Moynihan, CEO, and team can make due during this period of uncertainty. BofA's expense base has ticked higher due to COVID (in addition to its provision, obviously) but I would contend that management has levers to pull with the most notable example being expense management. 2020 has been a trying time for the large U.S. banks, including BofA, but I do not believe that the environment should be considered a game-changer when it comes to owning BAC shares.

The Low Interest Rate Environment That Just Keeps "Giving"

The low (and weakening) interest rate environment has been the number one concern raised by pundits, and rightfully so, as rates have continued to face downward pressure over the last few months.

Source: fred.stlouisfed.org

The pressures from the interest rate environment were felt this quarter as the bank's net interest income again ticked lower.

Source: Q3 2020 Earnings Slides

Notice the downward trend over the last 5 quarters. One point to make here: BofA has been hit hard due to its growing asset base during a low interest rate environment but I believe that this is a good problem to have if you are willing to look out a few years. At the end of the day, the interest rate environment is definitely a headwind (a short- to medium-term headwind, if you ask me), but that is not a reason to sell your BAC shares.

This bank has not only been able to report strong operating results through what has long been viewed as a "challenging" environment for the financials (and Q3 2020 was no exception), but it has also shown investors that the company is already well-positioned to weather a downturn. Moreover, the bank still has great long-term business prospects and it helps the bull case that a lot of the bad news is currently baked into the stock price, of course, in my opinion.

Valuation

BofA's stock is attractively valued based on the bank's own historical metrics.

Data by YCharts

Additionally, BAC shares are trading at attractive levels when compared to the bank's closest peer, JPMorgan Chase (JPM).

Data by YCharts

BofA should be trading more in line with JPMorgan, in my opinion. Citigroup (C) and Wells Fargo (WFC) are dealing with self-inflicted issues so there are reasons why the stocks of these two banks are cheap but, in my opinion, BAC shares should not be trading below its book value. I believe that valuation alone is a reason why BAC shareholders should seriously consider staying the course.

Risks

Regulatory concerns always need to be factored in when evaluating large financial institutions, and this includes Bank of America. I believe that the regulatory environment has improved, but this could change in short order.

The Federal Reserve and rates are a concern right now, but investors need to also consider the macro environment. A deteriorating economy in 2021 would negatively impact the banking sector. The COVID-related impacts should be closely monitored in the months ahead. If the economy is "shut down" again, BofA's stock will likely continue its downward trend.

Bottom Line

Bank of America is positioned to weather the COVID-related storms and the bank's stock will likely perform well during the recovery. I am not calling for a full recovery in the next 6 months but I do believe that the economy will be on more solid footing in the next 18-24 months, of course, if we are able to move past this global pandemic.

Simply put, I believe that Bank of America is well-positioned for a post-COVID environment and yes, that includes a time when rates will still be at historically low levels. And nothing that I read in the Q3 2020 earnings report changed my mind when it comes to the long-term bull case for Bank of America. As such, investors with a time horizon longer than the next few quarters should treat any significant pullbacks, especially if they are caused by broader market concerns, as long-term buying opportunities.

Disclosure: I am/we are long BAC, C. 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.