I’ve been bullish on Bank of America Corp (NYSE:BAC) for some time. But lately, I think the situation has gotten dicey — at least for the short run. In fact, BAC stock has already been coming under pressure. During the past month, the shares have been off 4%.
The fall-off in BAC stock has really been part of an overall slump in the sector, as seen with the drops in operators like JPMorgan Chase & Co. (NYSE:JPM) and Wells Fargo & Co (NYSE:WFC). Ditto for financial services-focused exchange-traded funds; the iShares Dow Jones US Financial Svc.(ETF)(NYSEARCA:IYG) is off just shy of 1% versus a similar gain in the S&P 500 Index since early August.
Why the concern? Well, for the most part, it’s something that BAC has little control over — that is, interest rates.
While the company does have various fee sources of revenues, the fact is that a substantial part of the monetization still comes from the net interest income. This is calculated as the difference between the revenues of the core banking services — such as providing loans — and the costs of paying interest on deposits.
Keep in mind that even a small change in interest rates can have an out-sized impact on the bottom line for BAC stock. For example, if interest rates increase by 1%, the net interest income should jump by $3.2 billion on an annual basis.
However, the problem now for BAC stock is that this relationship could go in reverse. That is, the yield curve has been tightening lately. Note that the spread between the 2-year and 10-year Treasury securities is about 0.78%. By comparison, it was 1.29% at the start of this year. Interestingly enough, the last time the spread was so thin was back in 2007, right before the financial crisis.
So what’s going on here? A key issue is that inflation has remained fairly tame. This is the case even though unemployment has been falling and the growth in the U.S. economy has remained healthy. For the most part, this has put the Federal Reserve in a tough spot. After all, the policy is to achieve inflation targets of roughly 2%. What’s more, there are also concerns that the recent impacts from hurricanes Harvey and Irma could result in major dislocations. So in light of all this, the Federal Reserve may hold off on hiking interest rates.
Long-Term Drivers for BofA
It’s true that BAC stock has several long-term drivers. First of all, the bank is likely to benefit from the aggressive push by the Trump Administration to reduce regulation, such as by paring back or even eliminating Dodd-Frank. Such moves should help to boost margins.
As well, BofA is a much leaner organization than 10 years ago. Since the financial crisis, the firm has engaged in tremendous cost-cutting and restructuring. As seen in the recent quarterly report, BAC is reaping the benefits of these measures, with profits climbing 10% to $5.27 billion. The company has also gained traction with its better risk systems. For example, in Q2 the net charge offs fell by 8% to $908 million.
Finally, BAC has tremendous scale. The assets come to roughly $2.6 trillion and there are 47 million customers. BofA has also used its heft to invest substantial amounts in R&D. For example, the company has 22.2 million mobile customers and 34.5 million active digital users.
Bottom Line On BAC Stock
It is definitely encouraging that Berkshire Hathaway Inc.’s (NYSE:BRK.A, NYSE:BRK.B) Warren Buffett has recently exercised the warrants on BAC stock. This is clearly a strong signal, considering that he is the bank’s largest holder.
Yet it is important to also consider that Buffett has already benefited from a big run in the stock — and yes, he has a long-term focus on things.
In other words, for those investors looking at BAC stock now, there is likely to be turbulence in the near future. So it is probably best to be patient when considering an entry point.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is also the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.
