You’d think that eight years after the financial crisis that all the banks would be in great shape. Yet, that’s not the case with Bank of America Corporation (NYSE:BAC). Don’t get me wrong — BAC stock is in far better shape, and much higher, than it has been.
But still, compared to its peers, it was struggling up until recently.
Fortunately, there are good things ahead for Bank of America stock, much of which was hinted at in its recent earnings report.
The Business Is Better
The key element for any bank, especially a big one like BofA, is growing its loan portfolio. However, that growth must be tempered with solid underwriting. In case you didn’t realize it during the mortgage crisis, even a small percentage of defaults can be devastating for a bank. One bad loan can wipe out the interest received in a year from 20 to 30 good loans.
We also want to see deposits growing, because banks use deposits to fund those loans, by borrowing those funds from depositors at ridiculously cheap rates.
I am fairly pleased with Q1 in that regard, with deposits up $64 billion and loans up $18 billion on the consumer side. One caveat: total credit/debit card spending was up 5%. This is actually not great for the long term, unless BAC is being extremely diligent with its underwriting. The American consumer is carrying way too much personal debt. Credit card debt is unsecured, so if the bottom drops out on personal income, these loans could go bad in a hurry.
Indeed, there was a quarter-to-quarter increase in provision for credit losses and total charge offs. The latter increased from $880 million to $934 million, a 0.42% ratio compared to 0.39%. Why? Seasonally higher credit card losses from consumer accounts. The credit loss provision had to be increased from $774 million to $835 million.
Net interest margin is one critical number I look at each quarter for BAC. Net interest margin is what banks make in profit on loans, after subtracting the relevant expenses. In the case of BofA, net interest margin increased from 2.23% to 2.39%.
This translates into another important metric: net interest income. That rose about $800 million to $11.3 billion. The reason for these increases is that banks actually like higher Fed interest rates because they affect borrowers more than banks.
It’s still a bummer that Bank of America is paying a measly 1.3% yield, or 30 cents per share per year. Yes, the bank must remain cautious, be patient and raise the dividend as appropriate.
Still, it makes shares far less attractive to dividend investors compared to its more generous peers JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC). I think that’s stifling the stock price a bit.
The reason can be traced back to ongoing expense issues. But eventually, one hopes expenses will stabilize. Along with growing deposits, improving net interest margins and net income, then the all-important dividend payout ratio will move down.
Bottom Line on BAC Stock
Still, it’s worth nothing that it isn’t the consumer division that is likely to be the growth engine for BofA. I think the investment and commercial banking sides are going to be where the action will be. In this past quarter, the investment bank saw a 12% sequential increase in fees. Remember, that division is basically the former Merrill Lynch, which is known throughout the world.
Commercial banking probably has a lot of room to grow. Loans increased by 8% on a 10% increase in deposits. That’s a little overheated for my taste, but not unreasonable.
On a relative basis, BAC stock isn’t unfairly valued, but my concern is more about the overall stock market being overvalued.
I think there’s a lot of long-term upside to BofA, but wait for a big correction.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
