Is Bank of America Corp (NYSE:BAC) really worth 30% more than what it was worth two months ago? The market says so, sending BAC stock from a close of $12.18 on June 27 to its current price near $16.00, making BAC one of the market’s hottest stocks for the timeframe.
In a nutshell, yes, BAC stock is deserving of such a move, not only to undo an undeserved steep pullback over the course of the first half of the year, but to reflect the bullish critical mass the bank has just achieved. In simplest terms, Bank of America’s numbers have finally reached escape velocity, and should start to look much better very soon.
BAC: That Which Doesn’t Kill You…
Although Bank of America managed to fight its way out of the 2008 subprime funk like most other bank stocks did, it has been an ugly, uninspiring journey. Last year’s net income of $3.8 billion hardly compares to the kinds of profits the company was producing pre-2008, as B of A has had to shrink its way to success.
That contraction was largely forced — demand for banking services like mortgage and business lending has diminished. In turn, Bank of America has been forced to cut expenses to match waning demand, and seemed to be playing catch-up rather than proactively managing those cost reductions.
At the same time, low interest rates kept the bank’s profits to a minimum. The difference between a bank’s own borrowing costs and its lending costs represent profits, and the lower interest rates are, the smaller this so-called “spread” is.
In many regards though, this period of slack demand and some tough decisions about which expenses made sense and which did not has made B of A into a lean, mean banking machine … arguably more so than any other bank.
The end result? With the prospect of rising interest rates against a backdrop of a growing economy, a fit-n-trim Bank of America could become next year’s Cinderella story. As Goldman Sachs analyst Richard Ramsden put it, “We believe that Bank of America is on the cusp of an inflection in operating leverage as revenue growth and cost reductions appear set to occur concurrently.”
The Planets Align for Bank of America
The encouraging outlook isn’t based on mere hope either … Bank of America has indeed been cutting expenses. For the first half of 2016, it spent about $28 billion, versus spending of roughly $36 billion during the first half of 2012, and incurring expenses of more than $40 million in the first six months of 2014. CEO Brian Moynihan plans on cutting another $5 billion in annual expenses by 2018.
At the same time, the banking industry as a whole is seeing a slight uptick in demand.
While the impact on the actual value of BAC stock isn’t crystal clear, during the second quarter of this year — a quarter marked by what seems like economic malaise — the Federal Deposit Insurance Corporation said banks’ aggregate net income was up 1.4% on a year-over-year basis. Home loans and credit cards balances were up.
The proverbial big Kahuna, however, is the impending rise in interest rates.
It has been a hotly debated issue to be sure. While Janet Yellen has threatened to push the Federal Reserve Funds Rate higher for months now, she has yet to actually do it. Last week though, Yellen took a more hawkish tone than she had in a long while. Her comments came in the shadow of surprisingly strong employment and four straight months of improved consumer spending.
Point being, there’s finally room and reason for higher interest rates, even if the market has yet to price them into bond prices and bond yields. The yield on two-year bonds is currently 0.789%, up from June’s low of 0.58%, but down from March’s high of 0.97%. They were at 0.71% a year ago.
As for how much of an impact a lift in interest rates might boost BAC stock, an across-the-board rate increase of 100 basis points would add $7.5 billion to Bank of America’s annual bottom line. It has earned $13 billion for the past four reported quarters, already hinting at better days with or without higher interest rates.
Bottom Line for BAC Stock
It took a long while to get here, but it was worth the wait. And, Goldman Sachs is right. While B of A has remained lackluster of late, the pace of its turnaround is likely on the verge of shooting higher — the near future is apt to look a whole lot better than the recent past.
It’s not an easy idea to embrace, in light of the company’s lingering lethargic results, but many of the planets have aligned, setting up an impressive 2017. Goldman thinks next year’s and 2018’s revenue should grow at a solid-single digit pace … which would be a huge victory for the long-beleaguered bank. A little more revenue now could mean a lot more profits per share of BAC stock.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
