Bank of America kicked off the latest earnings season last week by beating analysts' earnings estimates. The second-largest U.S. bank showed its resilience despite higher interest rates, which have started to drag net interest income.
Its relatively cheap valuation and the prospect of a Federal Reserve pivot on interest rates could make Bank of America an attractive investment.
Bank of America is very sensitive to changes in interest rates
Bank of America, also known as BoA, is the second largest bank in the U.S., and its diverse deposit base - spread across industries, geographies and customer classes - provides a stable anchor to navigate whatever the economy "throws at it." This diversity is important to the bank because its business is highly cyclical , meaning that it generally performs well during economic expansions but can underperform during contractions and recessions.
Banks also benefit from rising interest rates (to some extent) and BoA is one of the banks that are most sensitive to interest rates. Banks tend to benefit from rising interest rates early on because they can earn higher interest on their assets, while deposits take longer to adjust to changes in interest rates. In 2022, BoA's net interest income (NII) rose 22% as the Federal Reserve aggressively raised interest rates to curb inflationary pressures. Last year, the BoA's NII rose another 8.5% to $57 billion.
Conversely, higher interest rates can be a double-edged weapon for banks. BoA's net interest income, for example, fell 5% in the fourth quarter as deposit costs rose across the industry. BoA's cost of interest-bearing deposits was 2.5% in the fourth quarter, up from 2.2% in the third quarter and just under 1% a year earlier. As a result, its yield on earning assets declined to just under 2% in the quarter from 2.1%.
Higher interest rates continue to weigh on BoA's loan portfolio
When interest rates rise, loans, bonds or other securities held by a bank become less attractive compared to those that could be obtained at higher rates, and therefore bond prices and interest rates are inversely proportional.
In the fourth quarter, BoA had unrealized losses on its debt securities of $102 million. These unrealized losses could affect capital ratios or make banks more cautious about lending. On the positive side, this amount decreased from $136 million in unrealized losses in the third quarter as interest rates across its assets declined in the fourth quarter, increasing the value of its holdings.
BoA's cheap valuation makes it an attractive value stock
The turbulence in the banking sector over the past year has made BoA trading relatively cheap compared to recent history. While the stock is up 28% from its low point in October, its valuation is still reasonable, with shares trading at a 5% discount to book value and 1.3 times tangible book value. It is also well below its 10-year average price-to-earnings ratio.
Bank of America is a solid bank stock worth holding and in today's times it might be a good time to buy a few shares. Despite the recent 28% increase over the past few months, it wouldn't be too surprising to see bank stocks drop 10% to 15% in the short term. This could be a great chance to add more stocks, as the Fed's pivot will likely benefit more later this year and beyond.
