Since late October last year, Bank of America (NYSE: BAC) has been on a tear, increasing 58% as the Federal Reserve signaled a pause in its interest rate hiking campaign. The stock has gained significantly as investors priced in the pause and potential interest rate cuts at the end of this year and into next year, which could help alleviate pressure on the bank, whose loan portfolio has sizable unrealized losses.
However, it remains unclear where interest rates will be at the end of this year or next year. Coming into the year, markets priced in as many as six interest rate cuts. Those expectations are now down to two cuts. Given the recent run-up in the stock, is it wise for investors to buy now? Here are some things you’ll want to think about first.
Bank of America’s ballooning unrealized losses have drawn investor attention
Bank of America has over $2.5 trillion in total assets, making it the second-largest bank in the U.S., behind only JPMorgan Chase. Its sheer size makes it a behemoth, and it has held its own over time as one of the largest banks in the U.S.
Banks are simple businesses that take in deposits and make loans to customers. They earn money on the difference between the interest rate charged on loans and interest paid to customers for their deposits.
This business model makes the industry sensitive to swings in interest rates, and Bank of America’s sensitivity is evident by looking at its loan portfolio. These rising unrealized losses have been a concern among some investors as the Federal Reserve raised interest rates at the fastest pace in decades. Since the Fed began raising rates in 2022, the bank’s unrealized losses have grown from $14 billion to $113 billion.
Unrealized losses represent the losses Bank of America would take if it were forced to sell its securities in the market today. This doesn’t necessarily mean the bank is in trouble as long as it can hold those securities to maturity. However, a run on deposits at Silicon Valley Bank (a subsidiary of SVB Financial) last year forced the bank to raise capital and realize huge losses on its treasuries, which could have been even worse had the Feds not stepped in.
As one of the largest, most recognizable banks in the U.S., Bank of America has a well-diversified deposit base, with 37 million consumer checking accounts and almost $2 trillion in deposits from individuals and businesses. This provides it with a steady foundation for its business, making it less vulnerable to bank runs like those at Silicon Valley Bank and other regional banks last year.
BofA’s net interest income could continue to soar higher
The higher interest rate environment is a double-edged sword for banks. While Bank of America’s unrealized losses have ballooned, it has also benefited from a growing net interest income. The net interest income is the difference between the interest a bank takes on its loans and the interest it pays depositors.
When interest rates are low, as they were throughout 2021, a bank’s net interest income is low. However, during periods of rising interest rates, banks enjoy a tailwind as interest charged on loans adjusts quicker than interest paid on deposits. As one of the more interest rate-sensitive banks in the industry, Bank of America grew its net interest income from $43 billion in 2021 to $57 billion last year.
Today, banks are in limbo. In the first quarter, Bank of America’s net interest income fell compared to the same quarter last year. The bank grappled with rising interest expenses on deposits and slower loan growth as banks tightened lending standards amid rising charge-offs, which put pressure on its net interest spread.
Delinquencies and net charge-offs on consumer loans could be a short-term headwind for the bank, but Bank of America management sees a light at the end of the tunnel. During its first-quarter earnings call, CFO Alastair Borthwick said that delinquency trends were beginning to improve and that this would likely lead to charge-offs leveling out over the next quarter or two.
During this time, Bank of America has capitalized on the “higher-for-longer” interest rate environment by replacing lower-yielding assets with higher-yielding ones, which should help it grow net interest income late this year into early next year.
One analyst at KBW recently expressed optimism for Bank of America and projected its fourth-quarter net interest income to be 5% above its previous estimate. Analyst David Konrad said that net interest income and growth across other key parts of Bank of America’s business will help close the gap toward its target of delivering a 15% return on tangible common equity (ROTCE).
Is it a buy?
Bank of America stock has increased significantly since the Federal Reserve paused its interest rate hikes. Despite this rally, the stock is still reasonably priced at 1.6 times its tangible book value and 13.6 times earnings.
While its business ebbs and flows with the U.S. economy and prevailing market conditions, Bank of America has done an excellent job navigating market cycles. As one of the largest banks in the U.S. with a strong brand and robust balance sheet, the bank is poised to do well as it makes the most of today’s interest rate environment and is an excellent stock to buy today.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. SVB Financial provides credit and banking services to The Motley Fool. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America and JPMorgan Chase. The Motley Fool has a disclosure policy.
Is Bank of America Stock a Buy? was originally published by The Motley Fool
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