I upgrade my investment rating for Bank of America (NYSE:BAC) from Neutral to Bullish.
I last wrote about Bank of America in an article published on April 28, 2021, where I did a comparison of BAC and Wells Fargo (WFC). At that time, I rated BAC's and WFC's shares as Neutral and Bullish, respectively. In hindsight, this was not the best decision. Between April 28, 2021 and November 2, 2021, Wells Fargo's stock price rose by +15%, but Bank of America did even better with a +20% share price increase over this period. In this article, I focus solely on BAC and update my views on the bank.
Bank of America's earnings are expected to continue growing in the subsequent quarter and the next fiscal year, which is supported by the bank's positive guidance for net interest income growth. Looking beyond the next quarter or year, I see Bank of America reporting solid earnings growth over the subsequent five years, and the key bottom line drivers will be an increase in deposits, improved cost efficiency, and share repurchases. In considering BAC as a long-term investment candidate, it is noteworthy that the stock is valued by the market at a discount to some of its peers, and the bank has made good progress in terms of digitalization efforts.
I rate Bank of America's shares as a Buy now, taking into account the positive five-year outlook for the bank.
It is very likely that Bank of America will continue to grow in the near term. BAC's growth prospects in the short term are validated by the bank's Q3 2021 financial results which exceeded market expectations and the market's positive response to its recent financial performance.
Bank of America reported its earnings for the third quarter of this year on October 14, 2021 before trading hours, and the bank's stock price subsequently increased by +6% from $45.07 as of October 14, 2021 to $47.88 as of November 2, 2021.
BAC's good share price performance post-results announcement came about, as the bank's earnings per share jumped by +67% YoY from $0.51 in Q3 2020 to $0.85 in Q3 2021. In the company's earnings press release, BAC noted that "a reserve release of $1.1 billion driven primarily by asset quality improvements" was a key growth driver in the recent quarter. It is also noteworthy that Bank of America's third-quarter earnings per share were +22% higher than the Wall Street analysts' consensus bottom line forecasts.
The most important takeaway from Bank of America's Q3 2021 financial results is that the bank delivered decent growth in net interest income, on top of an increase in investment banking fees and sales & trading revenue.
Bank of America's investment banking fees grew by +23% YoY from $1,769 million in Q3 2020 to $2,168 million in Q3 2021, while its sales & trading revenue increased by +12% YoY from $3,224 million to $3,614 million over the same period.
But the continued growth in sales & trading revenue and investment banking fees is dependent on elevated levels of capital market activity going forward, and not necessarily sustainable. In comparison, net interest income is a relatively more sustainable source of future earnings growth, and this is an area that BAC has performed well in the recent quarter.
Bank of America's net interest income expanded by +8% QoQ and +10% YoY to $11,094 million in Q3 2021. At the company's Q3 2021 earnings call on October 14, 2021, BAC guided for "modest growth" for net interest income "in Q4", and it expects net interest income "in full year 2022 to be well above full year 2021." Bank of America also highlighted at its recent quarterly results briefing that it has witnessed "loan growth for two quarters now" and it "took in a lot of deposits" and "put some of those towards the loan growth." This implies that there are solid underlying fundamental drivers supporting the bank's future net interest income growth.
The sell-side consensus numbers also point to continued bottom line growth for Bank of America in the short term. Market consensus expects BAC's earnings per share to grow by +32% from $0.59 in Q4 2020 to $0.78 in Q4 2021 as per Seeking Alpha's Earnings Estimates page for BAC. Thereafter, sell-side analysts see Bank of America's earnings per share remaining stable at $0.78 in Q1 2022, prior to expanding by +4% QoQ to $0.81 in Q2 2022. Although it is uncertain when capital market activity will start to ease, BAC's net interest income growth should be able to help to offset any decline in investment banking fees and sales & trading revenue.
Besides assessing Bank of America's growth prospects in the near term, it is also important to evaluate the bank's outlook in the medium to long term as per the next section of my article.
Bank of America is expected to achieve a decent earnings CAGR of +6.5% between fiscal 2022 and 2026, based on data sourced from Seeking Alpha's Earnings Estimates page. I think that this is reasonable, with deposits growth, cost control, share buybacks helping to drive the bank's bottom line growth in the next five years.
BAC stressed at its Q3 2021 results call that the company's target is "to grow revenues faster than the economy and grow expenses at a rate of net 1%, maybe 2%", and emphasized that "we're really focused on is creating operating leverage."
The key driver of the growth in revenue and net interest income for Bank of America is expected to be the increase in deposits and the loan-to-deposit ratio. As per the company's 3Q 2021 investor presentation slides, Bank of America boasts the largest "retail deposit market share" in the US. The bank's total deposits grew by +15% YoY to $1.9 trillion as of September 30, 2021. Also, its loan-to-deposit ratio is estimated to be relatively low at around 47% in Q3 2021. Notably, the loan-to-deposit ratio for US banks in aggregate was above 70% in 2018 and 2019.
BAC has noted at the bank's third-quarter earnings briefing that "if deposits do decline, it will probably be many quarters, a couple of years maybe, after QE (Quantitative Easing) ends" and guided that "we expect deposit growth to continue." Looking ahead, the growth in deposits and the loan-to-deposit ratio should be supportive of Bank of America's net interest income growth in the coming years.
Separately, Bank of America has done a great job with controlling costs.
In Q3 2021, Bank of America's revenue increased by +12% YoY, but its non-interest expenses only grew by +0.3% YoY during this period. BAC's efficiency ratio, defined as "non-interest expense divided by total revenue, net of interest expense", also fell from 71% in Q3 2020 and 70% in Q2 2021 to 63% in Q3 2021, as per the company's 3Q 2021 investor presentation slides.
One example of opportunities for cost efficiency improvement is in the area of technology and cloud. In July last year, it was announced that BAC was "partnering with IBM (IBM) to create an industry-first, third party cloud." Bank of America highlighted at its recent earnings call that is the collaboration with IBM is "an effort to internalize the cloud that we can use in the financial service industry", and revealed that this is "saving a lot of money, and we continue to add modest amounts to the cloud."
Furthermore, share repurchases are also positive for BAC's future earnings per share growth. Bank of America spent $9.9 billion on share buybacks in Q3 2021, and the company's shares outstanding have been steadily declining from 8,651 million shares as of September 30, 2020 to 8,184 million shares as of end-September 2021. Moving forward, BAC should continue to return excess capital and reduce its share base via share repurchases for the foreseeable future. At the company's Q3 2021 earnings call, Bank of America did not disagree with an attendee's view that the bank's "acceleration of buybacks" is expected to be sustained.
While Bank of America is expected to deliver reasonably attractive earnings growth in the next five years, there are other factors to consider in determining if BAC will be a good long-term investment.
Apart from the medium-term earnings growth outlook, investors also need to look at Bank of America's digital disruption risks and valuations in assessing the bank's attractiveness as an investment in the long term.
As disclosed in the company's Q3 2021 investor presentation slides, BAC's number of digital active users for its consumer banking business increased by +4% from 39.3 million in Q3 2020 to 40.9 million in the most recent quarter, which translates to a digital household penetration rate of 70%. Furthermore, approximately 85% of deposit transactions in the third quarter of 2021 were executed via digital channels or automated teller machines/ATMs, rather than physical banking branches. The most important statistic is that BAC has "about 17% market share (of consumer checking accounts) in the Gen Z area that is heavily digitally-originated" as disclosed at its Q3 earnings call. This suggests that Bank of America has been actively tackling the issue of digital disruption.
BAC's Peer Valuation Comparison
|Stock||Trailing P/B Multiple||Consensus Forward FY 2022 ROE||Consensus Forward FY 2023 ROE||Consensus Forward FY 2022 Earnings Per Share Growth||Consensus Forward FY 2023 Earnings Per Share Growth|
|Bank of America||1.58||10.2%||10.9%||-9.6%||+14.1%|
|Morgan Stanley (MS)||1.94||13.5%||14.6%||-5.4%||+11.6%|
|JPMorgan Chase & Co. (JPM)||1.97||13.3%||13.9%||-20.0%||+9.9%|
Source: S&P Capital IQ
When it comes to valuations, Bank of America still trades at a significant discount to MS and JPM based on P/B multiples. Although this is justified to some extent by BAC's inferior ROEs, Bank of America is expected to deliver stronger bottom line growth as compared to JPMorgan and Morgan Stanley in fiscal 2023. FY 2022 is not a good basis for comparison as earnings are expected to normalize after an exceptional FY 2021 boosted by exceptionally high levels of capital market activity. While BAC's FY 2023 earnings growth is slightly lower than that of Wells Fargo, the former boasts much higher ROEs.
If Bank of America can meet market expectations in terms of a solid mid-single-digit earnings growth in the next five years, the stock's valuation discount as compared to JPM and MS has a good chance of gradually narrowing over time.
In a nutshell, Bank of America is a good long-term investment, as the bank has done well in the area of digitalization and there is room for an expansion in its P/B valuation multiple to bridge the gap with its peers.
BAC stock is a Buy now.
In my earlier April 28, 2021 article covering Bank of America and Wells Fargo, I noted the market's "disappointment with the bank's (Bank of America) 1Q 2021 results and relatively lower expectations of BAC's full-year FY 2021 financial performance." I also mentioned BAC's "expectations of higher expenses going forward" with the bank guiding for "its expenses to increase by approximately +2.7% YoY in FY 2021."
Bank of America's recent above-expectations Q3 2021 financial results and the marginal +0.3% growth in non-interest expenses for the recent quarter have changed my views of the stock. Given that I now have a more positive view of BAC's growth expectations in the next couple of years as discussed in this article, I decided to rate Bank of America's shares as Bullish or a Buy, rather than a Hold or Neutral previously.
BAC's key risks are slower-than-expected deposit growth, a larger-than-expected increase in non-interest expenses, a slower pace of share buybacks, a failure to execute well on digitalization efforts, and a valuation de-rating of the banking sector as a whole.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.