At the halfway point of 2016, shares in Bank of America Corp (NYSE:BAC) were sitting on a year-to-date loss of almost 30%. Today, BAC stock is up 20% for the year. Can there possibly be any value left to be had after such a 50-point swing?
If analysts at Keefe, Bruyette & Woods are on target, the answer is probably yes.
True, forecasts always rely on imperfect information and with the president-elect still putting his cabinet together, the inputs are more shaky than usual. But based on just a few likely changes, KBW expects the broader banking sector to benefit significantly from higher interest rates and lighter regulations.
KBW outlined some of its thoughts for the bank sector’s return on tangible common equity — ROTCE is a measure of profitability — next year:
“In our breakdown of bank profitability today compared to the period of peak profitability in the early 2000s, we roughly estimate that industry ROTCEs could move up 200 basis points from the current level of 12.3% under a possible scenario of higher interest rates and reduced regulation, assuming no change in tax rates. This suggests that a further 16% upside to the [KBW Nasdaq Bank Index] is possible based on today’s overall market values. However, the ability of banks to demonstrate higher profitability will take time and the avoidance of major credit issues. Further we do not have concrete proposals yet to provide detailed analysis.”
As KBW notes, this ignores any change to tax rates. But if the corporate tax rate were to drop by 10%, that would boost profitability by another 2%.
That’s quite significant and doesn’t appear to be baked into share prices. More to the point, if the BKX is poised for upside, then BAC stock should be too. After all, it has the greatest weighting in the index. Indeed, given BAC’s exposure to an interest-rate hike, Bank of America stock should outperform.
BAC Is Still a Buy
As the Motley Fool astutely noted, BofA is disproportionately poised to benefit from a rate hike. Take a look at its latest quarterly regulatory filing and you’ll see that Bank of America figures that if interest rates were to rise 1%, it would add an additional $5.3 billion in net interest income. For comparison, MF notes that JPMorgan Chase & Co. (NYSE:JPM) and Citigroup Inc (NYSE:C) would get another $2.8 billion and $2 billion, respectively.
The reason for this is that BAC holds the greatest amount of noninterest bearing deposits. This will essentially supercharge results. From MF:
“For Bank of America, this means that when interest rates rise, the amount of additional revenue it generates from its loan and securities portfolios outstrips the amount of additional interest expense it must pay on its liabilities. The effect is similar in one regard to that of operating leverage — growing revenue faster than earnings.”
BAC’s ability to add revenue from higher interest rates and leverage interest expense is a prime suspect in the sudden takeoff in shares. If that’s really the case, we should see more upside as we approach the date of the Federal Reserve’s next policy meeting as the market continues to buy the rumor.
And yet, even after the Fed pulls the trigger, BAC promises to be a market beater. Aside from deregulation and tax cuts, BofA will benefit from the broader trend of an improving economy.
Hiring is up, unemployment applications are at a multi-decade low and the housing market continues to improve. Bank of America’s broad and deep exposure to the domestic economy means that it’s set to profit more than most, even as its valuation remains depressed.
It looks like the stars are still aligning for BAC stock.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
