Bank Of America: The Stock Is Worth Holding Through The Uncertainty

Summary

• Bank of America's stock has significantly outperformed the broader market so far in 2021, even after factoring in the recent dip.
• The bank reported Q2 2021 results that were not well-received by the market. However, I believe that investors will be rewarded for holding onto their BAC shares through the uncertainty.
• We're long Bank of America, and we have no plans to reduce our stake in the near future.

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Bank of America's (NYSE:BAC) stock has performed well so far this year, as shares are outperforming the broader market by almost 10 percentage points over the last 7+ months.

Data by YCharts

More recently, however, the stock has been under pressure as concerns about the bank's near-term prospects have outweighed what I would consider a solid quarterly earnings report. To this point, BAC shares are down over 5% since the bank reported its Q2 2021 results.

BofA's earnings report was not well-received by the market due to several reasons, but, in my opinion, the long-term investment thesis for this bank 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, even through this period of uncertainty.

The Latest Uncertainty Remains But There Are Two Real Concerns

On July 14, 2021, BofA reported Q2 2021 results that beat on the bottom line but that missed the top-line estimate. The bank reported adjusted EPS of $1.03 (beat by $0.26) on revenue of $21.5B (missed by $300mm). The bank's earnings, and several key metrics, also compared favorably to the year-ago quarter.

Source: Q2 2021 Earnings Slides

Highlights for the quarter:

• Revenue was lower by 6% YoY, largely driven by lower rates.
• Net income was higher by 14% YoY, which included benefits from a reserve release ($1.6B) and a tax adjustment ($2.0B).
• Improvements in several key return metrics, as shown in the slide above.
• Strong capital return plans, which included an initiation of a share repurchase program of $25B and plans to raise the dividend by 17% in Q3 2021.

There was a lot to like about BofA's results, in my opinion, but pundits are largely focusing on two bearish themes: (1) interest rate pressure, and (2) loan growth, or lack thereof.

Interest Rate Pressure

The low (and weakening) interest rate environment has long been the number one concern raised by banking analysts, and rightfully so, as rates have remained at extremely low levels for an extended period of time. And BofA, and the other financial institutions, have felt the pain of this lower for longer environment - Q2 2021 was no exception, as the bank again reported a lackluster NII figure.

Source: Q2 2021 Earnings Slides

BofA's NII is down ~6% YoY, mainly driven by the lower rates. Plus, it's hard not to notice the extended downward trend in the bank's net interest yield. BofA is viewed as one of the financial institutions that would benefit the most from rising rates, so it should come as no surprise that pundits have raised concerns about the bank's near-term prospects in this challenging rate environment.

However, 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 a growing asset base should bode well for the bank's long-term prospects.

Loan Growth, Or Lack Thereof

The lack of loan growth has taken centerstage, as analysts have been stuck on the fact that BofA reported a 12% YoY decline in average loan and lease balances.

Source: Q2 201 Earnings Slides

The demand aspect in this environment is making it a real challenge for the banks, including BofA, to grow their loan books and it is showing up in the numbers.

Source: CreditSights

And while pundits still believe that BofA is well-positioned to benefit from a broader economic recovery, they are concerned about the bank's prospects for the next few quarters. Remember, the low rates are already a headwind so also factoring in tepid loan growth, only adds to the potential near-term challenges in this uncertain environment.

And I personally don't see any quick fixes here, even with management continuing to highlight their optimistic views about loan growth over the second half of the year. I anticipate this being a headwind through 2021 but, again, this does not change the thesis for this well-positioned bank.

The Takeaway: Uncertainty Remains But The Bank Is Solidly Positioned

No one can really predict where interest rates are going and, in my opinion, going forward there will be a lot of uncertainty when it comes to loan demand/the banks' willingness to lend in this environment. However, BofA has not only been able to report strong operating results through what has long been viewed as a "challenging" operating environment for the financials (and Q2 2021 was no exception), but this management team has also shown investors that the bank is well-positioned to weather storms, especially the ones that are short-term in nature. Moreover, the bank still has great long-term business prospects and it helps the bull case that a lot of the short-term headwinds are being baked into the stock price.

Valuation

BofA's stock is trading at the top of the range when it comes to two key valuation metrics.

Data by YCharts

However, 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. As such, valuation alone is a legitimate reason for BAC shareholders to 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 the second half of 2021 would negatively impact the banking sector. Additionally, the COVID-related impacts should be closely monitored in the months ahead. If the economy is impacted in a major way by COVID, i.e., the delta variant, BofA's stock will likely continue its downward trend.

Bottom Line

Make no mistake about it, rates and loan growth (or lack thereof) are real concerns that need to be monitored. But, Bank of America is positioned to weather the storms. Simply put, I believe that Bank of America is well-positioned for a post-COVID environment and yes, that includes a period of time with great uncertainty. And nothing that I read in the Q2 2021 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 interest rate or loan growth concerns, as long-term buying opportunities.

Disclosure: I/we have a beneficial long position in the shares of BAC either through stock ownership, options, or other derivatives. 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.