I correctly identified the potential in Bank of America’s (NYSE:BAC) shares back in October 2023, emphasizing the undervaluation of the stock in comparison to the bank’s robust earnings capability and expanding business domain. At that time, “irrational fear” among investors regarding losses in the bank’s securities portfolio presented an opportunity to acquire BofA stock at a discounted valuation.
Notably, since my initial assessment almost 3 months ago, BAC shares have soared by 28%, surpassing the S&P 500’s gain of 13%.
Following Bank of America’s recently released Q4 results, I reevaluate my positive stance on the bank’s stock, buoyed by the encouraging news of substantial paper losses in the securities portfolio dropping by about $33 billion during the December quarter, as a result of the anticipated 2024 Fed pivot.
Bank of America Exceeds Earnings Expectations
Despite a slight dip in profits during the recent Q4, Bank of America outperformed analysts’ predictions. The adjusted earnings per share stood at $0.70, surpassing the projected $0.64. This positive outcome was influenced by lower-than-expected provisions for credit losses, reduced by approximately $130 million compared to Q3, totaling $1.10 billion. Additionally, a more favorable operating expense base contributed to the positive performance, with salaries declining by around $100 million compared to Q3.
The bank’s quarterly net interest income almost matched consensus at $14.1 billion. Alongside this, the trading revenue experienced a modest uptick to $3.8 billion, driven by a notable 12% revenue surge in equities. The investment banking division also reported a 7% rise in fees, reaching $1.1 billion, supported by increased deal-making activity during the quarter.
However, as a non-operating headwind for Q4, it is important to note that the bank recorded charges totaling $2.1 billion, including a special fee to the deposit insurance fund, which had been depleted by a total of $16 billion the previous year to protect depositors from the Silicon Valley Bank and Signature Bank collapses. Additionally, there were extra charges of $1.6 billion related to the expiration of a Bloomberg interest rate benchmark used in some loan agreements.
Looking beyond the fluctuations on the income statement, a significant bullish signal for Bank of America shareholders is the reduction of unrealized losses in the bank’s securities portfolio, which decreased to $98 billion. Despite this still being a considerable amount, it’s important to recognize that in Q3, these losses totaled $131 billion, reflecting a favorable contraction of close to $33 billion.
Favorable Rate Outlook for 2024
Looking ahead to the new year, it’s expected that pressure on Bank of America’s HTM (held to maturity) portfolio will further ease, as the 2024 interest rate outlook has undergone a significant shift. The FOMC projections released in December diverged sharply from the previously prevalent “higher for longer” narrative. Notably, committee members have substantially revised down their end-of-year 2023 inflation estimates compared to their September assessments, expecting inflation to range between 2.8-2.9% year-on-year, a significant decrease from the prior 3.2-3.4% range.
In light of the expanding economy and diminishing inflation trend, FOMC participants have significantly adjusted their 2024 rate forecasts, now anticipating an approximate 75 basis points increase in the coming year, a significant change from the previous expectation of only about 25 basis points in cuts projected as recently as September. This rapid shift, occurring in less than three months, underscores a robust dovish momentum.
Notably, traders seem to be ahead of the Fed in anticipating rate cuts. Many traders expect the Fed to commence rate cuts as early as March, with a 75% probability of a 25 basis point rate cut according to the CME FedWatch tool. By the end of 2024, traders are currently forecasting a substantial 150 basis points in cuts, bringing rates to approximately 3.50 to 3.75%.
Given that Bank of America’s $1,205 billion bond portfolio appreciates by $33 billion on an approximate 1.2% yield drop in the 10-year Treasury, we can estimate that the bank’s HTM portfolio may appreciate close to $28 billion for every 100 basis points worth of rate cuts, which is equivalent to over 10% of BAC’s market capitalization as of early 2024.
Conclusion
Bank of America’s shares have performed remarkably since October 2023 when I advised a “Buy”, outperforming the S&P 500. Reflecting on Bank of America’s solid Q4 results, which affirm the bank’s robust earnings power and a ~$33 billion decrease in paper losses in the securities portfolio, I continue to be optimistic about BofA shares. The outlook for interest rates in 2024 enhances the potential for more upside in the bank’s HTM asset portfolio, which could lead to an asset appreciation of about $28 billion for every 100 basis points worth of rate cuts. Additionally, investors are likely undervaluing Bank of America’s robust earnings, with shares trading at less than 10x P/E. In my opinion, Bank of America stock remains a “Buy.”
