BAC Stock Plays in a Highly Cyclical Sector
Whenever we have a downturn in broader markets or talk of economic uncertainty, financial institutions get investors’ attention. Being a highly cyclical sector, bank shares are susceptible to changes in the economic climate, including interest rates, economic growth, housing market activity, global health, political and trade concerns.
If you are considering buying banking stocks, it’d be important to remember that two main factors affect a bank’s revenue and earnings:
- Interest rates: As interest rates increase, a bank can earn more money from its loan portfolio.
- Economic activity outlook: In a robust economy, more money circulates through the system, fueling a bank’s non-interest income.
Interest rates in the U.S. are currently at record lows. The lower the interest rate, the less a bank makes on its lending, while profit margins on the loans provided get squeezed. The Covid-19 pandemic is also expected to lead to a large number of bad loans, and banks have had to set aside considerable amounts of money for them.
Put another way, investing in bank shares now would possibly depend on your views about the short-term health of our economy. If the economy cools down further in the coming months, BAC stock is likely to be adversely affected.
How Q2 Results Came
Like other banks, BofA’s income is divided into two main categories: net interest income (NII) and non-interest income. It earns income on loans and other interest-earning assets. It pays interest on deposits and other interest-bearing liabilities. We can arrive at a bank’s net interest income by deducting interest paid from the total interest earned.
In general, decreasing interest rates mean headwind for banks including Bank of America as lower interest rates put pressure on NII and margins.
In mid-July, the lender released Q2 earnings. Revenue fell 3% year-over-year. Net interest income declined 11% to $10.8 billion, driven by lower interest rates, partially offset by loan and deposit growth. On the other hand, noninterest income rose 5% to $11.5 billion, led by strong capital markets results. Its bond trading revenue increased by 50% to $3.2 billion, and equities trading revenue climbed 7% to reach $1.2 billion.
Net income was $3.5 billion, or 37 cents per diluted share. Provision for credit losses increased to $5.1 billion. The bank has been building up its reserves to offset further adverse effects primarily associated with a weaker economic outlook.
CEO Brian Moynihan called 2020, “the most tumultuous period since the Great Depression.” He believes the current recessionary environment will extend well into 2022.
In short, the quarterly results showed pandemic-driven uncertainties remain. Following the release of the results, BAC stock has been volatile. The following few days it suffered losses, from which it has now fully recovered. The shares are up about 5% since mid-July.
Is the Dividend Safe
The recent declines in share prices of financial firms show that investor sentiment remains fragile. Yet, many investors include banks typically in their portfolios due to their relatively high dividends.
On June 25, the Federal Reserve announced the results of its annual stress tests and additional sensitivity analyses for banks. The Fed required 33 of the largest U.S.-based banks to preserve capital by suspending stock repurchases and cap dividend payments in the third quarter.
In several other countries, financial institutions have also decreased or completely suspended their dividend payments. When the passive income element is gone, dividend investors look for alternatives.
Although Bank of America has not yet cut its dividend, investors are wondering if it may be forced to do so in the coming quarters. The current price supports a dividend yield of 2.8%. A potential dividend cut would put further pressure on BAC stock.
Are you an investor who pays attention to short-term technical charts? You may be interested to know that BAC stock is unlikely to make a new leg up in the coming weeks. Instead, the share price will possibly stay range-bound, between $22.50 and $25.
At this point, we’d not rush to buy BAC stock. However, we’d reevaluate the fundamentals if the price goes toward, or even under $22.50. The current forward P/E and P/B ratios stand at 12.02x and 0.92x, respectively. A further share price decline of around 7%-10% would improve the margin of safety.
The Bottom Line
Most financial institutions, including BAC stock, have underperformed so far in 2020. Due to the health and economic effects of the pandemic, banking cycle in the U.S. isn’t at its most attractive point.
Recent research by Pancheng Qu of Duke University highlights just how relatively stable the BAC stock price has been over the duration. In case of further pullbacks in the shares in the coming days, investors may consider buying into BofA stock on the dip. Patient market participants are likely to see their investments grow in two to three years.
On the date of publication, Tezcan Gecgil did not hold (either directly or indirectly) any positions in the securities mentioned in this article.
The author has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. She also publishes educational articles on long-term investing.