The past month and a half have been plenty rewarding for patient owners of Bank of America Corp (NYSE:BAC). After a so-so first ten months of the year, something lit a fire under BAC stock, sending it 40% higher since the end of October.
Granted, predictions of higher interest rates (predictions that were right, by the way) and the prospect of a business friendly President-elect justified the bullishness.
Still, a 40% gain in less than two months’ time is a bit daunting; can BofA really justify this new lofty price? In fact, it probably can once it reports the current quarter’s earnings in mid-January.
In fact, it may well end up dishing out a pleasant surprise for three key reasons.
Three Reasons BofA Is Set for a Surprise
1. Wider Net Interest Margins
Along with October’s report, Bank of America said that a 100 basis point increase in short-term interest rates would add $3.1 billion in annual income to the bank’s bottom line, while a 100 basis point rise in long-term rates would lift the bottom line by $4.5 billion. If both short-term and long-term rates grew by 100 basis points, it would add a total of $7.5 billion worth of annual income.
We didn’t get 100 basis points worth of a rate-hike from the Federal Reserve last week; we only got a quarter of that. Moreover, BofA will only enjoy that benefit for two weeks out of the 13-week quarter. A funny thing happened well before the Fed dished out a quarter-point rate hike last week though. Since the end of September, interest rates for intermediate-term bonds soared nearly 100 basis points.
It’s not clear how much of that gain actually helped Bank of America widen its spread … the difference between what it pays to borrow money and what it charges to lend money. It must also be recognized that one quarter is only a fraction of one year. But, even at the prorated low-end of the bank’s outlook, BAC could create an extra $750 million or so worth of Q4 income thanks to the way rates have been on the rise thus far this quarter.
2. More Trading Activity
To say the market went hog-wild in response to Trump’s victory is an understatement.
Since Nov. 8, the S&P 500 has gained nearly 6% as a flood of buyers poured into the equity market, and they traded … a lot. That bodes well for the company’s investment management arm, which turned $4.4 billion worth of revenue in the third quarter to income of $700 million. Roughly $2.1 billion of that revenue came from asset management fees and $900 million came from brokerage activity.
Unfortunately, BofA doesn’t divulge too many details about its daily, weekly or even monthly investment management business. Rival E*TRADE Financial Corp (NASDAQ:ETFC) does, however, and E*TRADE reported last week that its November trading revenue was up 40% on a year-over-year basis, and up 23% from October’s levels.
Assuming BAC saw anything close to that kind of uptick in business for its brokerage business, and assuming typical industry margins, this arm could add an extra $250 million in income for the quarter currently underway.
3. Continued Cost Cutting
Finally, CEO Brian Moynihan wasn’t just blowing smoke earlier in the year when he said he believes he can cut another $5 billion worth of annual expenses by 2018. In fact, he’s already been doing it, aggressively. During the third quarter, year-over-year non-interest expenses fell by $400 million … a pace he has kept for a while.
Assuming he finds another $400 million worth of costs to cut this quarter, that whole amount goes straight to the bottom line for BAC stock.
Bottom Line for BAC Stock
To some extent these tides have already been factored into analysts’ outlooks; the pros are suggesting the bank will earn $4.08 billion this quarter, or 38 cents per share of BAC, on revenue of $21.01 billion, both of which are better than the year-ago bottom line of (or 27 cents per share) and top line of $19.56 billion.
In light of the fact that these same analysts have already underestimated a less potent Bank of America in each of the past six quarters though, the analyst community hasn’t exactly demonstrated they fully grasp all the progress BofA is making.
Based on the above estimates for revenue and earnings growth in excess of what expected before Trump-mania and higher interest rates went into effect, BAC stock may be realistically adding nearly an extra, unexpected billion dollars to the currently expected bottom line of $4.08 billion for the current quarter. On a per-share basis that translates into an extra seven cents, give or take, for Bank of America.
BAC stock owners would love for analysts to make that mistake.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
