- Bank Of America is poised for growth as illustrated in its latest set of earnings. However, Its recent rally has been mainly due to hype. Investors will get a better entry if the Fed doesn't move in December
- The bank's NIM metric is definitely keeping profits low but a 1% hike in interest rates would make a bank an extra $3.7 billion
- Ignore the dividend potential. This is a growth stock and the bank should issue large share buybacks (as shares are undervalued). Buybacks should reward shareholders more than bigger dividends
BlackRock (NYSE:BLK) recently decided to take on the investment responsibilities of $87 billion of money market assets from Bank of America (NYSE:BAC). Although being a large deal, I believe the lost revenue to Bank of America is meaningless. The transaction is in line with the bank's efforts of simplifying its business so it can grow faster over the long term.
Bank of America definitely has higher growth potential than other banks in this space, but now may not be the time to invest. Why? Well the bank has had an enormous run up in its price over the last month (12%+ - see chart) and I just feel that the stock will come back to its 200 day moving average in the near term because this move has been unprecedented and may have been caused by external factors.
What I am referring to is the October FOMC meeting and the Fed's posture on interest rates. The market definitely took a hawkish stance to interest rates which resulted in many of the financials rallying for subsequent days after the meeting. However investors shouldn't overlook the fact that Bank of America rallied harder than all of its main peers such as U.S. Bancorp (NYSE:USB), JP Morgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC). This means that if the Fed doesn't move in December (which I believe will happen) Bank Of America could easily drift lower like we saw over the Summer months this year. Therefore I would wait to get long this stock despite the sound fundamentals the stock possesses. Let's discuss.
Firstly the bank definitely seems to have momentum behind it as it announced a terrific set of earnings results for the third quarter a few weeks ago. However the market didn't take very well to the news and the stock didn't rally much on the news. I see the market sentiment as an opportunity because when you delve into the numbers, it is quite apparent that the bank is improving across many metrics. The bank's mortgage related problems now seem to be totally behind it as this was illustrated in earnings as originations increased by 13% over the 3 months. Other earnings highlights included a 4% hike in deposits and non interest expense (excluding litigation expense which has dropped rapidly since the great recession) falling by 4% and continued out-performance of the Merrill Lynch businesses. So why hasn't' the market rewarded shareholders is the question? Well the main metrics (net income and revenue) fell compared to last quarter and the third quarter of 2014, and where many analysts are seeing stagnation, astute investors see opportunity. Why? Well the growing deposit base can become a serious asset for the bank if interest rates were to rise meaningfully in the next few years. Holding this capital (until the bank can loan out more profitably) seems to be a prudent play at this time.
The bank's conservative and forward looking approach has also resulted in a weak "NIM" or net interest margin metric in the third quarter. Investors need to take into account that there is very little the bank can do in this area. If building a deposit base is more important than handing out consumer loans, then the bank's NIM metric will continue to drop, especially if interest rates don't rise. Its a waiting game the bank is currently undergoing. One thing is for sure; if interest rates remain low, the bank may need to become more aggressive in this area and change its strategy of lending so cautiously.
Furthermore, with the bank having a current price to book ratio of 0.71, this company appears much cheaper than its peers (see chart below). Its book value per share is north of $22 which is attractive especially when you take into account that interest rates could rise in the US in the near term which should boost net interest income meaningfully. Moreover this bank seems to be the one bank that is more aggressive than its competitors regarding the shutting down of branches, which is an endeavour that again should bear fruit in the years to come. The bank cut its branches by 206 in the third quarter, which means that the 7% drop in its workforce over the last 12 months will continue in the year ahead. These steps will help the company gain traction in the future as it costs 90% less to process a mobile based transaction compared to a branch based one according to the CEO Brian Moynihan.
Near term economic events are going to be critical in determining the way in which the Fed moves in December. The government is expected to add 178,000 jobs in October on Friday morning compared to 142,000 added in September. Auto sales are still strong but factory orders fell for a second consecutive month in September illustrating reduced investment - especially in energy. Nevertheless Friday's jobs number is key. If it comes in well behind expectations again, the Fed will not raise rates this year, period. $3.7 billion was the number quoted by the company regarding the extra profit it would make if interest rates rose by 1%. No wonder the stock rallies hard on every hawkish announcement by the Fed. It has everything to gain but it could easily give back its recent gains if the Fed moved to a more dovish stance.
Finally there has been a lot of talk about this bank raising its dividend in the near term due to the health of its balance sheet. Personally I don't see this bank as an income play but a growth play as the shares are trading on the cheap (as discussed above). Therefore investors looking for income should avoid this stock. It pays a 1.16% yield which is low compared to a Wells Fargo for example, which pays out a 2.73% yield and is building up a record of increasing dividends. What Bank of America should do is buy back its own shares which should enable the stock to rally from present levels.
To sum up, I see this bank definitely with growth potential but it may not come in the near term. Its recent rally has been built on hype if not anything else, despite the sound set of earnings it delivered in October. Personally I feel the Fed wont raise rates which may cause the stock to pull back from present levels. However If I am wrong and interest rates rise, which could be potentially followed by a strong buyback program (which still would have to be Fed approved), then this stock undoubtedly should be the outperforming bank in this sector.