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Bank of America (NYSE:BAC): Expanding Interest Yields Could Boost the Stock
Stock Analysis & Ideas

Bank of America (NYSE:BAC): Expanding Interest Yields Could Boost the Stock

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Bank of America’s latest results displayed solid net interest yield growth, boosting its profitability. Future risks remain, but the stock appears cheap at its current levels relative to its bottom-line prospects and capital returns potential.

Bank of America’s (NYSE:BAC) Fiscal 2022 results showed expanding net interest yields and improving profitability. Combined with shares trading at an attractive valuation and capital returns likely to accelerate moving forward, there is a strong bullish case to be made for the stock following last year’s losses. Accordingly, I am bullish on the stock.

Rising Rates Improve Profitability

Rising interest rates are currently benefiting Bank of America’s profitability, as the company is able to achieve expanding interest yields. It’s worth noting that rising rates do not necessarily mean the company can earn higher net interest margins.

This is because as interest rates rise, it also becomes more expensive for Bank of America to attract deposits (i.e., they may have to pay higher rates to depositors to keep their money), which can result in a decline in net interest margins.

Indeed, for Fiscal 2022, the company reported a net interest spread of 1.6%, which was actually lower than last year’s net interest spread of 1.7%, with average deposits declining $92 billion, or 5%, to $1.9 trillion.

However, Bank of America’s net interest yield, which measures the income generated by a bank’s earning assets, such as loans and investments, relative to the bank’s interest-bearing liabilities, has still been on the rise as rates have been moving upwards.

This is because Bank of America is now able to generate more interest income from its earning assets than it pays out in interest on its liabilities. Specifically, Bank of America’s net interest income hit $14.8 billion in Q4, up 29.7% year-over-year, boosting the bank’s net interest yield to 2.22%, up from 1.67% in the prior-year period.

Higher interest yields boosted profitability in Consumer Banking, with the segment posting a record net income of $3.6 billion, up 15%. This was despite higher provisions for credit losses and business investments. Following this increase, even though headwinds in Investment Management and Global Banking resulted in net income declines of 2% and 5% in each segment, respectively, Bank of America’s total net income still rose by about $100 million to $7.1 billion.

Stock Buybacks Likely to Accelerate

Bank of America’s spending on repurchasing its common stock has been quite a roller coaster ride. In 2019, the company’s stock repurchases hit a record of about $28.1 billion. Then, in 2020 management paused buybacks mid-year to conserve liquidity as the pandemic hit. Buybacks amounted to just over $7 billion that year. With euphoria in the markets returning in 2021, buybacks skyrocketed back up to $25.1 billion.

Then, demoralization once again returned in 2022, with buybacks fading. In Q1, Q2, and Q3 of 2022, the company repurchased just $2.7 billion, $975 million, and $450 million, respectively, which clearly outlines a downward trend. However, repurchases rebounded to about $1 billion in Q4, which likely signals that buybacks will re-accelerate in 2023.

The possibility for boosted buybacks is also supported by the fact that the company enhanced its balance sheet, For example, its CET1 ratio (which looks at a bank’s capital relative to its assets) increased by 20 basis points sequentially to 11.2%.

Considering that management had previously aimed toward an 11.4% CET1 ratio by 2024, repurchases are likely to accelerate as they have essentially hit their target prematurely.

Lastly, due to shares trading at a forward P/E ratio of about 9.6x, which is below the stock’s average levels, management could be driven to buy some stock on the cheap.

What is the Main Risk to BAC’s Profitability?

The most noteworthy factor that could negatively impact Bank of America’s profitability and bullish case moving forward is the possibility of an inverted yield curve occurring in 2023.

An inverted yield curve basically means that short-term interest rates are higher than long-term interest rates. Banks like Bank of America borrow money at short-term rates and lend money at long-term rates. When short-term rates are higher than long-term rates, the model breaks. The spread between the two narrows, which would reduce the profits Bank of America can make from its lending operations.

Is BAC Stock a Buy, According to Analysts?

Turning to Wall Street, Bank of America has a Moderate Buy consensus based on seven Buys and five Holds assigned in the past three months. At $40.81, the average Bank of America stock forecast implies 15.8% upside potential.

The Takeaway

Bank of America ended Fiscal 2022 on an encouraging note. With the possibility of a recession and a yield-curve inversion, which could impact the bank’s future earnings potential, profitability has so far remained robust, and net interest yield on assets is on the rise.

The stock’s valuation is below its average levels, and earnings growth could improve further, boosted by the Wealth Management segment if market conditions start to normalize. Also, there is the possibility of stock repurchases accelerating. Therefore, Bank of America’s bullish case appears more reasonable than the bearish one, in my view.

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