Bank of America Corp (NYSE:BAC) is up 35% since Donald Trump’s election and well into new five-year-high territory. So it would be understandable to expect BAC stock to peel back just a little.
But don’t mistake a bit of profit-taking in Bank of America shares as a hint about the shape of things to come. Any ebb would likely be just a short-term headwind, driven by nothing more than profit-taking.
See, with the Federal Reserve on the verge of upping interest rates (it may already have happened by the time you read this) in addition to a business-friendly Trump slated to take the Presidential oath of office soon, BAC stock could be a nice pickup on any decent dip.
Throw in a mostly overlooked quirk about BofA, and Bank of America shares could be a surprisingly savvy buy after a pullback.
The Rising Tide
There’s no sense in ignoring the 800-pound gorilla in the room. By Wednesday afternoon, the Federal Open Market Committee (FOMC) meeting should have finished, and the Federal Reserve should have bumped up the Fed funds rate — the nation’s foundational interest rate — by a quarter of a point, if the prognosticators and traders are on target.
On the off chance it doesn’t happen, much of what you’re about to read still applies (bullishly) to Bank of America.
The upside of higher interest rates to all banks including BofA isn’t exactly a veiled secret. Banks charge borrowers a rate based on the market’s prevailing rate at the time the loan is made. If rates are broadly higher, banks charge more.
Granted, banks must also “borrow” the very money they lend, and banks’ borrowing costs edge higher when rates rise as well. However, those borrowing costs don’t grow to the same degree that consumer- and business-loan rates grow when rates rise.
In other words, banks make more money when interest rates are higher, and there’s little doubt rates are on the rise. If not today, then soon, and likely more than once before the end of 2017.
But it’s not just the rising tide that makes BAC stock a standout among the banking industry’s biggest names.
Bank of America Is Uniquely Well-Positioned
As was noted, the difference between its own borrowing costs — in most cases the interest it pays on checking and savings account deposits — and the interest rates its customers pay represents a key component of any bank’s profit mix.
But what if a bank didn’t have to pay anything to borrow money it was lending out to customers?
To a large extent, this isn’t a mere dream for Bank of America. It has access to more “free money” than any of its peers do.
BofA isn’t the nation’s biggest bank as measured by customer deposits. That honor belongs to JPMorgan Chase & Co. (NYSE:JPM). Bank of America does, however, boast the biggest pool of deposits that don’t bear any interest payments for their owners. As of last quarter’s tally, Bank of America is home to $439 billion worth of non-interest-bearing deposits, versus JPMorgan’s $409 billion.
This is essentially free money for the bank, and a key part of the reason the organization is so highly levered to changes in interest rates.
And Bank of America hasn’t been shy about telling BAC stock holders about it. It has crunched the numbers and concluded that for every additional 1 percentage point added to the market’s rates, the bank will enjoy an additional $5.3 billion in interest income per year.
For perspective, BofA has earned net income of $14.8 billion over the course of the past four quarters.
Looking Ahead for BAC Stock
As encouraging as Bank of America’s nuance is for current and would-be shareholders, just as encouraging is the fact that the company is culling costs … big-time.
As yours truly noted back on Sept. 2:
“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.”
That cost-cutting effort hasn’t been altered in the meantime, meaning the bank will soon be doing even more, with less.
None of this fundamental strengthening will be able to stave off a near-term setback for BAC stock. But such a correction should be soon as an opportunity rather than a concern. Any pullback here is more of a procedural, technical one than a reflection of the stock’s value.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
