Is Bank of America stock a buy?

american bank (BAC 1.54%) Last week, the company started its latest earnings season by beating analysts’ earnings estimates. The second-largest U.S. bank showed resilience even as rising interest rates began to weigh on net interest income.

Bank of America could be an attractive stock given its relatively cheap valuation and the expectation that the Federal Reserve will focus on interest rates. Here’s what you need to know first:

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 United States, and our diverse deposit base, which spans industries, regions, and customer groups, provides us with a stable anchor to weather any economic challenge. I am. This diversity is important for banks. Because banking business is highly cyclical. This means that they typically do well during economic expansions, but may perform poorly during recessions or downturns.

Banks also benefit (to some extent) from rising interest rates, and BoA is one of the most interest rate sensitive banks. Banks tend to benefit from rising interest rates early because they can earn higher interest rates on their assets, while deposits take longer to adjust to changes in interest rates. BoA’s net interest income (NII) increased by 22% in 2022 as the Federal Reserve aggressively raised interest rates to curb inflationary pressures. Last year, BoA’s NII increased by a further 8.5% to $57 billion.

Conversely, rising interest rates can be a double-edged sword for banks. For example, BoA’s NII fell 5% in the fourth quarter as deposit costs rose across the industry. BoA’s interest-bearing deposit cost 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, the yield on earning assets fell from 2.1% to just under 2% in the quarter.

Rising interest rates continue to weigh on BoA’s loan portfolio

One of the numbers often scrutinized for BoA ​​is the unrealized losses on its loan portfolio. As interest rates rise, loans, bonds, or other securities held by banks become less attractive compared to those that can carry higher interest rates. Therefore, bond prices and interest rates are inversely related.

In the fourth quarter, BoA had unrealized losses on debt securities of $102 million. These unrealized losses may affect capital adequacy ratios or cause banks to become more cautious about lending. On the positive side, this amount is down from his $136 million unrealized loss in the third quarter, as interest rates fell across assets and holding values ​​rose in the fourth quarter.

These unrealized losses will not be a problem as long as banks can hold the stocks for a long time. One of the problems with the regional banks that went bankrupt last year was that their financial base had shrunk due to huge deposit outflows.Some niche banks like (a subsidiary of) Silicon Valley Bank SVB Financial) or silver gate bank, relied on low-cost deposits to fund their operations. But for the first time, they saw their deposits drained for various reasons, forcing them to either raise capital or sell their loans at a significant loss.

Fortunately for BoA, the bank continues to grow its deposit base. At the end of the quarter, its total deposits stood at $1.9 trillion, up a modest 0.7% since the Fed began raising interest rates in the first quarter of 2022. Although this increase has been slow, it is a positive sign and evidence of a diversified deposit base. It endures difficult times.

Image source: Getty Images.

Focus on consumer credit indicators

Another important metric investors will want to watch is BoA’s credit quality. Consumers are piling up debt, with credit card debt exceeding $1 trillion last year. Rising interest rates have put pressure on consumers who have relied heavily on credit card loans, making it one of the areas where BoA has seen a significant increase in charge-offs. The net charge-off rate for consumer credit card loans exceeded 3% in the fourth quarter, up from 2.7% in the third quarter and 1.7% a year ago. However, the charge-off rate for the entire loan portfolio was 0.45%, still in line with pre-pandemic levels.

Due to the cyclical nature of bank stocks, investors always want to keep an eye on a bank’s creditworthiness. An increase in write-offs could lead to further provisions being built up, which could put pressure on the bank’s profits in the short term.

BoA’s cheap valuation makes it an attractive value stock

Due to the turmoil in the banking industry over the past year, BoA is trading at a relative discount compared to recent history. Although the stock is up 28% from its October lows, its valuation remains reasonable, with the stock trading at a 5% discount to book value and 1.3 times tangible book value (excluding intangible assets such as goodwill) has been done. The price-to-earnings ratio (P/E) is also well below the average over the past 10 years.

BAC price to book value data by YCharts. P/E = price/earnings ratio.

Is Bank of America a buy?

Bank of America is relatively cheap and well-positioned to benefit from the possibility of the Federal Reserve cutting interest rates in 2024. CME GroupThe market is currently pricing in seven rate cuts, bringing the federal funds rate from 5.5% to 3.75% by the end of this year, according to FedWatch’s FedWatch tool.

As noted above, higher interest rates weigh on BofA’s net interest margin and loan balances, so lower interest rates should alleviate these pressures. The rate cut could also stimulate demand for loans from consumers and businesses who have been waiting for lower rates to refinance or take out new loans.

Bank of America is a bank stock worth owning, and today might be a good time to buy a few shares. Still, it wouldn’t be too surprising to see bank stocks fall 10% to 15% in the short term, given their recent 28% rally in recent months. This could be a great opportunity to add to stocks, as the Fed’s policy changes are likely to benefit the market further beyond the end of the year.