Bank of America (NYSE:BAC) played a crucial role as the Federal Reserve turned to it for assistance during the 2008 economic crisis. With support from the Federal Reserve, the bank managed to navigate the challenging times and emerge stronger. However, the financial market continues to be puzzled when it comes to understanding “mark-to-market” valuations. It’s important to clarify that mark-to-market has little impact on a business as long as it is assumed to be a going concern. This confusion often leads to the misconception that healthy companies are at risk of potential losses that do not actually exist. This phenomenon can be likened to the presence of an “elephant in the room.”
A Simple Example: The Home Ownership Analogy
Let’s consider the concept of owning a home. Many of us remember the inflated prices of houses before the market crash in 2006. While the value of our homes may have plummeted during the crisis, most of us did not sell our houses and move into apartments. Instead, we continued living in our homes, weathering the ups and downs of the housing market. The reason being, we had other priorities that constituted our personal “going concern” business. This analogy illustrates the advantage of not constantly buying and selling assets like houses, just as investors do with their investments. Consequently, the investment strategy known as “buy-and-hold” gains an upper hand over frequent trading, as it allows investors to focus on long-term gains rather than short-term market fluctuations.
Similarly, in the business world, the value of assets can vary with market conditions. However, if a company utilizes those assets, such as government securities, until maturity or until they are no longer functional, the market value becomes less significant. What truly matters is whether the asset generates a profit for the business.
Security Analysis: Decoding the Supposed Loss
Now, let’s address the concern surrounding the bank’s reported loss of approximately $136 million. It is essential to understand that the book value of assets will naturally fluctuate over time due to market conditions. However, the bank’s primary focus is on managing cash inflows and outflows in order to maintain a balanced financial position. Furthermore, the bank diversifies its investments to mitigate errors or assumptions that may initially seem reasonable but turn out to be otherwise. Therefore, the supposed loss of $136 million should not be a cause for alarm.
What The Bank Says: Clarifying Investment Strategy
“In late 2020 and into 2021, we concluded that additional stimulus was going to remain in client accounts for an extended period, and we increased the hold-to-maturity securities portion so we could lock in value from those deposits. And we made these investments given the core nature of our customers’ deposits.”
(Source: Bank of America Third Quarter 2023, Earnings Conference Call Transcript)
It is essential to recognize that the slides and figures presented earlier do not paint the full picture. The bank’s investment decisions were based on a strategy to generate profitable returns from the excess deposits held in client accounts. This approach aligns with the bank’s commitment to maximize the value derived from its customers’ deposits. Therefore, the focus should not solely be on the market value of the securities, but rather on how much profit they contribute to the bank’s overall earnings.
While it may be tempting to criticize the bank’s investment choices based on the hindsight of future market conditions, it is crucial to acknowledge the risks associated with such decisions. The bank cannot be expected to accurately predict future interest rates and market conditions. Making decisions based on perfect knowledge of the future would have entailed significant risks, potentially resulting in substantial losses. Therefore, it is essential to consider the potential costs involved before concluding that the bank could have made more money.
Actually, It’s The Liquidity That Matters
“You’ll note that we’re now paying 155 basis points all-in for deposits, which is up 31 basis points from last quarter. Best that you remember 2 things when you think about the deposits. The rate remains low relative to many because of the transactional nature of our deposit relationships, with $565 billion in noninterest bearing deposits. And you can see in the upper right alone, in low-interest and no-interest checking, there’s $504 billion in Consumer. We remember the importance of the spread against the quarter’s average Fed funds rate. This position is very advantaged compared to past cycles because the transactional accounts in the current cycle are a much higher mix of Bank of America’s deposits. I would also add that while we maintain discipline in deposit pricing, we paid competitive rates to customers with excess cash seeking higher yields across all the businesses, if rates fall, those particular products will see the rates come down also.”
(Source: Bank of America Third Quarter 2023, Earnings Conference Call Transcript)
It is crucial to understand that the size and scale of the bank’s operations offset any concerns about specific securities. With over $3 trillion in assets, Bank of America has the resources and capabilities to meet necessary financial stress tests. Consequently, the performance of individual securities that may currently be underwater should not cause significant concern in the investment community as long as the bank remains strong and diversified.
Going Forward: A Powerful Player in the Banking Industry
Looking ahead, Bank of America is well-equipped to meet any potential regulatory requirements aimed at reducing bank leverage. The bank already possesses sufficient shareholders’ equity to fulfill increasing demands and may even consider further equity buildup as a precautionary measure. Furthermore, the bank’s geographical diversification, coupled with its ability to generate non-interest income from subsidiaries and fee-based services, provides a competitive advantage unavailable to smaller banks.
Bank of America’s income has experienced double-digit growth compared to the previous year, and this trend is likely to continue. As a comprehensive financial institution, the bank offers a broad range of services, making it a convenient one-stop-shop for individuals and businesses alike. Consequently, investing in Bank of America can be seen as a long-term growth and income opportunity, with the potential for a combined yield in the low teens from both dividends and capital appreciation. Additionally, when interest rates decrease, there may be additional room for appreciation. Therefore, investors may view Bank of America as a strong buy and a potentially core holding in their portfolio.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
