In the aftermath of three regional banking collapses earlier this year, the U.S. banking sector has wrestled amid dwindling deposits with customers seeking higher yields, escalated deposit costs, low loan growth, and shrinking profit margins. However, the industry showcased a degree of stability.
This semblance of recovery emerged as the Federal Reserve raised the benchmark interest rates to the peak in over two decades, a trend anticipated to reverse in the upcoming year. Typically, increased interest rates produce gains for banks through elevated net interest income.
Nevertheless, the U.S. banking sector persists in hemorrhaging deposits. Deposits have declined for the fifth consecutive quarter ending June 30, 2023. During the second quarter alone, FDIC-insured banks witnessed a nearly $100 billion drop in deposits.
Furthermore, the industry’s net income saw a $9 billion reduction to $70.80 billion in the second quarter, and the average net interest margin shrank by three basis points to 3.28%.
The perceived stability was also questioned merely two weeks after Moody's decided to downgrade the credit ratings of 10 mid-sized and smaller banks. Adding to the unease, bond rating agency Fitch has issued warnings, and subsequently, S&P Global Ratings cut the ratings of five American banks and put an extra two on alert, given the increasingly complex high-interest rate business climate.
Such a succession of downgrades from credit rating agencies could make obtaining loans more complex and costly for borrowers. Shares of the nation’s second-largest bank, Bank of America Corporation (BAC), suffered along with other bank stocks after Fitch’s warnings.
The Current Scenario
BAC has reported an increased number of its customers struggling with credit card payments, acknowledging that its credit card sector's performance lags behind expectations. Rising charge-off rates delineate this underperformance.
In the second quarter of 2023, the bank saw consumer net charge-offs hit $869 million, up from $571 million from the prior year quarter. Concurrently, provisions for losses remained steady at $1.1 billion.
A surge in the net charge-off rate and the delinquency rate of BAC's BA Master Credit Card Trust II were noted in August. Nevertheless, these rates are still below those recorded before 2019.
The net charge-off rate for the trust was 2.13% in August, up from 1.89% in July but significantly less than the 2.49% registered in August 2019. Likewise, BAC's delinquency rate escalated to 1.26% in August, slightly higher than July's figure of 1.24% but keeping under the 2019 benchmark of 1.57%. While these elevated rates might indicate stable consumer conditions, some may perceive them more pessimistically.
BAC's principal receivables outstanding were valued at $13.8 billion in August, suggesting a nominal shift in lending activity relative to the preceding month. Until recently, consumers were predominantly focused on clearing their credit card and other loan debts. However, current macroeconomic instabilities might put this trend into reverse.
The Real Picture
U.S. consumers have demonstrated robust financial activity throughout this year, with persistent spending expected to catalyze a third-quarter GDP growth of up to 3.5%. Harnessing the ability of credit cards and buy-now-pay-later (BNPL) services, consumers continue to shop. Despite various cost-saving efforts, current consumption patterns still surpass the average consumer's affordability.
Bank charge-offs and write-offs maintained a steady level until a shift occurred in July when the country's six major banking institutions disclosed the highest loan loss rates since the onset of the pandemic. Credit card repayments were disproportionately affected. Credit card loans constitute nearly 25% of BAC's total charge-offs.
These heightened charge-off rates signal potential challenges as more consumers default on their monthly payments. This trend is emerging in a financial landscape where consumers grapple with escalating costs and interest rates. Concurrently, wage stagnation lags behind inflation, and supplemental benefits have been reduced.
Current consumer spending reflects necessity instead of robustness. Consumers are compelled to spend more despite receiving marginally lower goods or services than before. Instances of arrears are recorded across multiple debt avenues, including credit cards, auto loans, mortgages, and student loans. The absence of immediate full payment has fostered a propensity toward overspending.
Unsustainable spending patterns may cause a downturn in consumer spending by early 2024, fueled by mounting credit card debts and dwindling pandemic-era surplus savings. The second quarter witnessed a 4.6% spike in consumer credit card debt, setting a record $1.03 trillion, as opposed to $986 billion in the first quarter.
As the burden of irrecoverable debt continues to strain lenders' financial stability, net charge-offs for BAC will keep rising.
Investors might want to consider the following additional factors:
BAC has been imposed with staggering financial penalties in the recent past, totaling $250 million, following a series of dubious practices that include overdraft fee manipulation, withholding credit card rewards, and the initiation of unauthorized accounts. While this may have short-term impacts on its financial performance for the upcoming quarter, it is not expected to cause substantial overall financial implications.
Furthermore, the bank ended the second quarter incurring over $100 billion in paper losses due to its aggressive investment in U.S. government bonds. This figure significantly surpasses the unrealized bond market losses of BAC's competitors.
BAC's investments in technology are evidently paying off. Its digitization efforts have successfully translated into an unprecedented increase in Zelle transactions by more than double since June 2020, along with a digital banking adoption rate of 74% among households. Engaging customers via online and mobile transactions is significantly less costly for the bank than traditional in-person interactions.
Over the past three years, the financial institution has conscientiously refined and modernized its financial centers nationwide. This integral enhancement enables the bank to bolster its digital services and effectively cross-market various products.
By 2026, it envisages expanding its financial center network into nine emergent markets. In conclusion, its investments in technology are expected to bolster the bank's operating efficiency.
On August 29, BAC declared the introduction of its highly acclaimed Global Digital Disbursements platform to commercial clients who hold deposit accounts at the bank's Canadian branch.
With this innovative solution, users can process an array of B2C payments and C2B collections using the client's email address or mobile phone number as identifiers. This feature presents a cost-effective and user-friendly alternative for companies seeking to replace cash or cheque payments.
For the second quarter ended June 30, 2023, BAC’s total revenue, net of interest expense, increased 11.1% year-over-year to $25.20 billion. Its net income applicable to common stockholders rose 19.7% year-over-year to $7.10 billion.
Additionally, its EPS came in at $0.88, representing an increase of 20.5% year-over-year. Also, its net interest income rose 13.8% over the prior-year quarter to $14.16 billion. In addition, its CET1 ratio came in at 11.6%, compared to 10.5% in the year-ago quarter.
Over the past three and five years, BAC’s revenue grew at 8% and 2.5% CAGRs, respectively. Its net interest income for the same periods grew at CAGRs of 6.4% and 4.3%, respectively.
Net income and EPS grew at 13.6% and 18.8% over the past three years, whereas, over the past five years, these grew at 6.7% and 12.8%, respectively. The company’s total assets grew at 4.4% and 6.4% CAGRs over the past three and five years, respectively.
In terms of forward non-GAAP P/E, BAC’s 8.67x is 4.4% lower than the 9.07x industry average. Likewise, its 0.87x forward Price/Book is 10.4% lower than the 0.97x industry average.
On the other hand, in terms of forward Price/Sales, BAC’s 2.32x is 2.1% higher than the 2.27x industry average.
BAC’s trailing-12-month Return on Common Equity (ROCE) of 11.41% is 1% higher than the 11.30% industry average, whereas its trailing-12-month Return on Total Assets (ROTA) of 0.95% is 16.9% lower than the 1.15% industry average.
The stock’s trailing-12-month cash from operations of $44.64 billion is significantly higher than the industry average of $137.73 million.
Growing Institutional Ownership
BAC’s robust financial health and fundamental solidity make it an appealing investment opportunity for institutional investors. Notably, several institutions have recently modified their BAC stock holdings.
Institutions hold roughly 69.7% of BAC shares. Of the 2,816 institutional holders, 1,226 have increased their positions in the stock. Moreover, 139 institutions have taken new positions (42,890,796 shares).
The stock has declined 13.5% year-to-date to close the last trading session at $28.65. However, over the past year, it lost 17.4%, whereas over the past six months, it gained 3%.
Shares of BAC have been making lower highs for the past 12 months, but they have not made a low since March. Its share price displayed upward and downward movement multiple times from January to September 2023. The overall value so far declined compared to the beginning of the year.
Moreover, BAC’s stock is trading below its 100-day and 200-day moving averages of $29.19 and $30.7, respectively, indicating a downtrend.
However, Wall Street analysts expect the stock to reach $35.13 in the next 12 months, indicating a potential upside of 22.6%. The price target ranges from a low of $27 to a high of $49.
Mixed Analyst Estimates
For the fiscal year ending December 2023, analysts expect both BAC’s revenue and EPS to increase 6.3% year-over-year to $100.91 billion and $3.39, respectively. Its revenue and EPS for fiscal 2024 are expected to decline 0.8% and 4.2% year-over-year to $100.13 billion and $3.25, respectively.
Moreover, for the quarter ending September 2023, its revenue is expected to surge 2.5% year-over-year to $25.12 billion, whereas its EPS is expected to decline marginally year-over-year to $0.80.
The recent upturn in bank charge-offs marks a return to normalcy for the industry after an unprecedented period of low levels during the pandemic, attributed largely to decreased unemployment and substantial government financial relief initiatives.
However, this surge in 2023 introduces an anomaly in the banking sector. Several banking institutions have acquiesced under pressure, and financial experts caution that should unemployment rise above 7%, the industry could face significant complications.
Moreover, consumers will face the reinstatement of student debt payments throughout the latter half of the year, as the forbearance period concludes in October. This would force customers to navigate difficult choices regarding credit card and student debt payments, potentially causing a broader impact on delinquency rates nationwide.
Major banks maintain a positive front that there is little cause for concern moving forward. However, this optimism may rely heavily on steady unemployment rates around the 5% mark - a contingency for which plenty of banks have pre-prepared provisions. Yet, if unemployment rates deteriorate further, banks and consumers could encounter hardship during the latter half of 2023.
Despite the adversities presented, BAC continues to display a robust capacity for growth amidst a tumultuous climate. Notably, despite a downshift in revenues and net income for its Global Wealth and Investment Management unit during the second quarter, the bank still surpassed Wall Street's top and bottom-line estimates.
Also, in the last reported quarter, when most finance firms recorded subdued Investment Banking business performance, BAC’s IB numbers were impressive. Its total IB fees of $1.21 billion increased 7.4% year-over-year, which boosted its global banking unit's net income by 76% to $2.7 billion.
Nevertheless, considering the bank’s tepid price momentum, mixed analyst estimates, valuation, and profitability, it could be wise to wait for a better entry point in the stock.