Bank of America’s Q3: A Decisive Beat (NYSE:BAC)

Bank of America Corporation (NYSE:BAC) just released its fiscal third quarter earnings. The release beat on revenue and as well as on EPS. Going into the release, analysts were expecting the following:

• $25.07 billion in revenue.

• $0.82 in earnings per share (“EPS”).

Relative to these expectations, BAC’s reported results were very good. The company delivered large year-over-year increases in revenue as well as earnings, and deposits only declined 4% year over year, actually rising $1 billion sequentially.

As a whole, Bank of America’s earnings release confirmed what I’ve been saying about the bank (and its stock) all year: that it remains one of America’s best financial institutions, despite the magnitude of its unrealized losses.

BAC stock has fared worse than its peers this year, because of the perception that its $100 billion unrealized treasury loss spells big liquidity issues on the horizon. Although its earnings grew just like those of JPMorgan Chase & Co. (JPM), Bank of America did not rise in the market this year, thanks largely to liquidity concerns. BAC’s unrealized loss was the biggest of its peer group, and made up about one sixth of the total unrealized losses at U.S. banks at the time.

It’s true that unrealized losses can cause liquidity problems, because they reduce the actual value of held-to-maturity bonds (compared to their reported value). However, a bank having heavy unrealized losses doesn’t mean it has a liquidity problem. As I showed in several past articles, Bank of America’s liquidity even after subtracting unrealized losses from the bond portfolio is better than that of many of its peers. The bank’s third quarter results confirmed what I’d been saying, as total liquidity (after adjusting to fair value) was 52.5% of deposits. That’s an excellent liquidity metric, among the best of the big banks that have reported Q3 earnings so far.

In this article I explain why I remain bullish on Bank of America after its third quarter earnings release. I review the bank’s earnings, and show why they portend more strong quarters to come. I take a look at BAC’s valuation, showing that it’s among the cheapest of its peers. Finally, I explain why liquidity and risk management are strong points for Bank of America, contrary to popular opinion.

First things first, let’s take a look at that earnings release.

Third Quarter Earnings Recap

Bank of America beat analyst expectations in the third quarter, delivering the following headline metrics:

• $25.2 in revenue, up 3%, a beat by $130 million.

• $7.8 billion in net income, up 9.8%, a beat.

• $0.90 in diluted EPS, up 11%, a beat.

• $8.1 billion in operating income, down 2.4%.

• $614 million in net interest income, up 4%.

• $1.9 trillion in deposits, down 4% year-over-year, up $1 billion sequentially.

These metrics were pretty encouraging, especially the deposits. The reason why deposits and liquidity have been such a concern among BAC shareholders this year is because some think that the bank’s depositors will start fleeing to treasuries if the bank doesn’t raise savings account interest enough. It was this kind of situation-a bank run combined with inadequate liquidity-that caused Silicon Valley Bank and First Republic to fail. Fortunately, Bank of America’s deposits remain in place, declining only 4% year-over-year, and the bank could survive a 52.5% loss of deposits.

Valuation

Having looked at Bank of America’s most recent earnings release, we can now turn to the stock’s valuation. Normally I use multiples from Seeking Alpha Quant for this section of the analysis, but since Bank of America’s release is only a few hours old, I’ll need to build the multiples up from scratch.

Below you can see the last four quarters’ worth of revenue, operating income (“EBIT”), net income and EPS for Bank of America. The “Q3” column tells you the amounts for the quarter just reported. The TTM column gives the trailing 12 month totals – I don’t fill in the whole-firm figures in this column because only the per share figures are relevant to calculating multiples. The book value row only has one cell in the “TTM” column because that metric isn’t additive.

Click to enlarge

From the per-share TTM column and Yesterday’s closing price of $26.99, we get the following multiples:

• Price/earnings: 7.56.

• Price/sales: 2.12.

• Price/EBIT: 6.50.

• Price/book: 0.8265.

All very low ratios which, when combined with the bank’s solid growth and liquidity, suggest that BAC may be a bargain.

Profitability

Bank of America’s Q3 earnings release, in addition to showing strong year-over-year growth and good liquidity, also showed some very impressive profitability metrics. Using figures from the release, we can calculate the profitability ratios below:

• EBIT margin: 32%.

• Net margin: 30.9%

• Return on equity (“ROE”): 11.2%.

• Return on tangible equity: 15.5%.

All of these margins/returns on equity are very high, suggesting a profitable enterprise. Seeking Alpha’s TTM profitability ratios tell a similar story, with a 31% net margin and an 11.4% ROE.

Growth

Last but not least, let’s look at Bank of America’s growth. Since I already went over the previous quarter’s growth rates in the earnings recap, I’ll spend this section talking about the bank’s future growth potential.

The economic environment in 2023 is both promising and challenging for banks. Lenders in principle should make more money in this environment compared to previous ones, because they collect more interest revenue when rates rise. Certainly, Bank of America’s Q3 earnings release is consistent with that. However, the yield curve is inverted-this may force BAC to raise deposit interest in order to retain depositors. Presently, the spread between savings account rates and mortgage rates is so wide that banks (including BAC) are enjoying huge margins. Will interest revenue actually grow in 2024? That’s too specific to say with certainty, but if the yield curve begins to un-invert, and if a recession is avoided, then BAC’s margins will increase and the bank may even begin to release some of its provisions for credit losses. That could cause significant growth in margins even without much revenue growth-you’d expect some deceleration in revenue because the TTM growth rate was far higher than the five year CAGR rate.

Risks & Challenges

As we’ve seen, Bank of America has put a good quarter behind it, and looks poised for more good quarters. It’s a compelling picture. Nevertheless, there are some risks and challenges worth bearing in mind here:

• Persistent yield curve inversion. The treasury yield curve has been inverted ever since the second quarter of 2022. An inverted yield curve should theoretically squeeze bank margins, because it increases the attractiveness of short term treasuries compared to bank deposits. So far, Bank of America’s margins have remained high despite the inverted curve. But perhaps word about the high treasury yields is simply taking a long time to reach mom and pops, who will start demanding higher interest rates once they realize what’s available from Uncle Sam. That could either squeeze Bank of America’s margins or cause liquidity issues, depending on what approach the bank took to addressing the situation.

• A possible recession. Most economists surveyed on the matter still think that a recession is coming within the next 12 months. The forecasts that said there’d be a recession in 2023 didn’t come to pass, but that could be because the Fed’s rate hikes haven’t had the time to work their way through the system and “trickle down” to the consumer. I don’t personally think a severe recession in the near future is a foregone conclusion, but some macro factors suggest that a mild recession is more likely than not. If that were to come to pass, you would expect less loan issuance and more loan defaults, two factors that would hurt Bank of America’s bottom line.

The risks facing Bank of America today are very real. Smaller banks collapsed this year due to factors like those mentioned above. Nevertheless, Bank of America is very liquid, despite all the unrealized losses, and is still generating strong growth and fat margins. I’m content being long this stock for the time being.