Bank of America just ended a weak quarter - but there were three little-noticed bright spots

Around Christmas last year Bank of America It looked like one of the biggest comebacks in banking history had made it. After flirting with bankruptcy in the great financial crisis, BofA made $ 29 billion in net income for half a decade for 2019, a 75% increase in just two years. CEO Brian Moynihan did what seemed impossible: Closing the profit gap with the longtime Universal Banking Champion, Jamie Dimons JPMorgan Chaseand BofA easily outperforms another rival it has long lagged behind, Wells Fargo. At the end of 2016, Wells Fargo's market cap was 40% higher than BofA's. Then BofA started and Wells, who was marked by scandals, stopped. By the end of 2019, BofA's share price had doubled to $ 35, and its valuation of more than $ 300 billion dwarfed Wells by the same 40%.

Then the COVID-19 crisis hit BofA's profits and share price. By discounting a modest valuation heavily, Wall Street signals that the bank will earn much less going forward than it did last year.

The new earnings report makes investors even more negative. On October 14, BofA announced a sharp drop in profits to levels well below JPMorgan's numbers revealed the day before. Net income for the third quarter declined to $ 4.9 billion from $ 5.8 billion in the second quarter and $ 7.0 billion in the fourth quarter of 2019. In contrast, JPMorgan grossed $ 9.4 billion in the third quarter, making it the second-best quarterly figure in its history. BofA's results deeply disappointed Wall Street, lowering its shares 5.33% to $ 23.62 at close of trade. This sell-off came as a bit of a surprise as the numbers were more or less in line with analysts' expectations. BofA just exceeded the FactSet consensus for the result. Revenue fell only 2%, far exceeding the cost of borrowing. They were nearly half a billion dollars, or a third below Wall Street's expectations.

As he made clear on the call, Moynihan is doing nothing to change the stable course that looked like such a winner a few months ago. He employs a compelling consumer strategy: instead of aggressively promoting banking products or even attracting new customers, he focuses on growing with his existing customers by gaining a greater "share of the wallet" with increasing incomes and needs. The idea is for people with checking accounts in BofA's 4,300 branches to stay with the bank to get credit cards, auto loans, and mortgages, and manage their nest egg through a private banker or financial advisor from Merrill Lynch. That's one thing Moynihan says, "sticks to your ribs."

Since the BofA finances its gigantic US $ 1 trillion in loans almost entirely from highly affordable deposits, it is certain to make big and growing profits as long as it keeps overheads and borrowing costs in check. So far, Moynihan has achieved both goals and has kept total costs practically constant. It keeps the defaults for banks among the lowest as it makes credit card loans to people who are already solid customers and avoids high risk to high risk sectors like commercial real estate.

What may be problematic is that profits haven't fallen because the COVID-19 crisis sparked another wave of credit losses. Instead, the basic business of BofA throttled back. So the question arises: will the BofA get back on track quickly and earn around $ 30 billion a year, or will a low-interest post-pandemic economy mean that the BofA will be consistently less profitable than it was in recent years golden years?

One thing is certain: Wall Street now expects BofA to earn even less in the coming quarters than the $ 4.9 billion in the third quarter. BofA's current market cap is $ 205 billion, up from $ 305 billion at the end of 2019. Let's say investors give their stocks a price-earnings multiple of 15, which is well below the S&P 500 average of 21 in the past three decades. If so, they'd expect BofA to make just $ 14 billion a year, or $ 3.5 billion a quarter, 29% less than the third quarter. Talk about how low expectations are.

This author, who praised Moynihan's approach to growing with your customers when he introduced it in 2011, is counting on the BofA to make a big recovery.

Here are takeaways that point to a revival in future quarters.

The cost of borrowing has gone from huge to normal, and Moynihan believes he pre-booked all of the damage

As I described in my story in the JPMorgan Chase report, a new accounting systemSince the beginning of 2020, banks have had to post all forecast losses over the entire term of all loans in the current quarter. This also applies if the borrowers are still paying on time. Rather than gradually taking on this expense as loans actually default, banks now need to take on the entire wallop upfront.

As a result of the new regulations, BofA made provisions of $ 9.9 billion in the first and second quarters of 2020 – a direct blow to earnings. That's nearly three times the total for full 2019. However, borrowing costs declined to $ 1.4 billion in the third quarter. Progress has been particularly impressive at the consumer bank, which also provides small business lending, with provisions increasing from $ 2.55 billion in the second quarter to just $ 479 million.

Of course, the BofA made those huge accruals in Q1 and Q2 as their models, based on extremely conservative assumptions about future GDP growth and unemployment, predict that they will end up in loans of $ 9.9 billion to businesses and burden people affected by the pandemic. But as Moynihan noted on the conference call, we have seen little sign of damage so far. Only 0.54% of BofA consumer loans of over half a trillion dollars are more than 30 days past due. The mortgages, auto loans and the like that are no longer covered by forbearance have few defaults. As Moynihan put it, the depreciation expected from the major provisions in the first half of the year "has not yet occurred".

Moynihan said he didn't expect depreciation to increase until mid-2021. "What we expected in the third quarter has been and is being suppressed," he said, attributing the delay in part to government support for families and small businesses, but also noted that the excellent consumer balance of payments so far is a signal Seems to be These losses may not be as high as BofA expects.

Still, he says, there is "too much uncertainty" to begin running on reserves, a move that would and could turn out to be a win for profits. In a statement that represents good news for future earnings, Moynihan predicted that the BofA now has all the reserves it needs to weather the crisis. In this case, the provisions should be minimal in the next few quarters.

But here's the problem: provisions were already low in the third quarter, but BofA earned 16% less than in the third quarter of last year, not to mention 30% less than in the fourth quarter. What is holding BofA back and will the slowdown continue?

The BofA relies on low interest rates and a flatlining loan portfolio

A key source of growth is NII, or net interest income. Over the past year, BofA's NII rose over $ 700 million to 1.5%. While this is a marginal increase, the BofA was able to maintain its already high profitability, which was helped by Moynihan's signature on spending. However, in the second quarter, NII fell from $ 12.34 billion to $ 10.24 billion, or 17%. The decline has two causes. The first was a fall in interest rates, which narrowed the margin between what the BofA collects on its loans and what it pays to depositors and savers. Second, the BofA loan book not only stopped growing, it also shrank a little. The total portfolio declined $ 18 billion, or 1.85%, over the past year.

In addition, total costs of $ 14.4 billion were almost 5% higher than the annual rate in 2019. Moynihan and CFO Paul Donofrio attributed the increase to an increase in one-time litigation costs and additional costs of $ 300-400 million Crisis, including spending on processing millions of small business PPP loans, a burden only partially offset by fees.

To get back to the pre-COVID pace, the BofA NII needs to grow again and cut costs

As Moynihan confirmed on the conference call, interest rates on his loan portfolio should remain extremely low going forward. As he also pointed out, the BofA can offset this resistance by expanding the loan book that is now on the water. In other words, attracting more borrowers will more than make up for the lower monthly credit card loan and mortgage payments.

This is exactly what BofA has been doing for a number of years and is doing it for sure. The total loan portfolio grew over $ 40 billion, or 4.4%, from 2017 to 2019, largely in line with the economy, including a $ 4 billion increase in credit card loans with average interest rates of 10.8%.

But can BofA let its loan book grow again? A chime is what happens to deposits. Earning millions more checking account customers means these additional households will grow their income by raising more credit card, auto, and home loans over time. Over the past year, BofA's consumer deposits have grown by a fifth, from $ 709 billion to $ 861 billion. Incidentally, the decline in interest rates is anything but negative; The average BofA payments for these deposits have decreased from 0.11% to 0.05%. (The additional cost per dollar for deposits in labor, real estate, and the like is an additional 0.8%, making a grand total of well under 1%. See why banking can be a great deal?)

Therefore, the BofA seems to be quickly gaining customers and market share. That is, his loan portfolio should grow perhaps a point faster than real economic growth. It is also likely that Moynihan will bring spending back down to its previous rate of around $ 55 billion a year, keeping increases below inflation, as in the past. The additional process costs will expire, as will the additional expenses for COVID.

Of course, BofA is essentially a machine designed to expand with Americans' incomes and increase profits by keeping spending constant dollar for dollar. So if family income and GDP remain unchanged over a longer period of time, the income of the BofA will suffer. A bet that the US economy will return is also a bet that BofA profits will only recover faster.

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