Bank Of America Strategists Expect 3 Rate Hikes And A Flat Stock Market In 2020

New York during the COVID-19 emergency.

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Introduction: Why Is BAC Stock Going Up?

We review our Bank of America Corporation (BAC) investment case after Q4 2021 results on Wednesday (January 19). BAC stock closed up 0.4%.

Bank of America has been a core holding in our portfolio for more than a decade, and we initiated our coverage of BAC on Seeking Alpha with a Buy rating in October 2019. Since our initiation, shares have returned 73% (with dividends), including 48% in 2021 and 4.4% year-to-date:

Librarian Capital Rating History on BAC vs. Share Price (Last 1 Year)

img src="https://static.seekingalpha.com/uploads/2022/1/19/589751-16426329158057806.png" alt="BAC vs. Share Price (Last 1 Year)" hspace="6" vspace="6" loading="lazy"">BAC vs. Share Price (Last 1 Year)

Source: Seeking Alpha (19-Jan-22).

Q4 results support our investment case, with accelerating loan growth and good expense control. BAC is well-placed to be a key winner from U.S. interest rate hikes in 2022.

Our updated forecasts show a total return of 41% (9.4% annualized) by 2025 year-end. The current Dividend Yield is 1.8%.

BAC Buy Case Recap

The core of our investment case is that BAC will maintain a long-term Return on Tangible Common Equity ("ROTCE") of 16% on a growing capital base, as measured by Tangible Book Value ("TBV").

A 16% ROTCE will be similar to the levels in 2018 and 2019, and achievable with a recovery in Net Interest Income ("NII") (from both higher rates and loan growth), Non-Interest Revenues being only moderately lower than in 2020 and 2021, and continuing operational leverage.

BAC Group ROTCE (Since 2013 vs. Long-Term Forecast)

img src="https://static.seekingalpha.com/uploads/2022/1/19/589751-16426289175923448.png" alt="BAC Group ROTCE (Since 2013 vs. Long-Term Forecast)" loading="lazy"">BAC Group ROTCE (Since 2013 vs. Long-Term Forecast)

Source: BAC results supplements.

NB. Excludes $2.07bn First Data JV impairment in 2019.

We expect BAC to grow its TBV by retaining part of its earnings after dividends and buybacks. BAC is not constrained by regulations from having a larger balance sheet, unlike peers JPMorgan (JPM) and Wells Fargo (WFC).

We expect a 14x P/E at the end of our investment period. On a 30% Payout Ratio, this would imply a Dividend Yield of 2.0%.

BAC finished 2021 with a ROTCE of 17.0%, with operational drivers and management comments both pointing to a similarly healthy ROTCE in future.

Q4 2021 Results Headlines

BAC's Q4 Pre-Provision Profit Before Tax ("PBT"), which excludes reserve releases or builds, was 12.0% lower than Q3 but 18.7% higher year-on-year; there is a clear up trend since Q3 2020, despite quarterly volatility:

BAC Earnings, Provisions & Pre-Tax Profit by Quarter (Since Q3 2019)

img src="https://static.seekingalpha.com/uploads/2022/1/19/589751-16426363593305795.png" alt="BAC Earnings, Provisions & Pre-Tax Profit by Quarter" hspace="6" vspace="6" loading="lazy"">BAC Earnings, Provisions & Pre-Tax Profit by Quarter

Source: BAC results supplements.

NB. Figures on managed basis.

The sequential decline in Pre-Provision PBT was primarily due to an 8.8% decline in Non-Interest Revenues (largely from lower Sales & Trading revenues); NII grew 2.8% and Non-Interest Expenses rose just 2.0%. The strong year-on-year growth in Pre-Provision PBT was the result of good revenue growth (in both NII and Non-Interest Revenues) and operational leverage (with expenses only rising 5.8% while revenues grew 9.8%):

BAC Results Headlines (Reported Basis) (Q4 2021 vs. Prior Year)

img src="https://static.seekingalpha.com/uploads/2022/1/19/589751-16426374033532152.png" alt="BAC Results Headlines (Reported Basis) (Q4 2021 vs. Prior Year)" loading="lazy"">BAC Results Headlines (Reported Basis) (Q4 2021 vs. Prior Year)

Source: BAC results supplement (Q4 2021).

ROTCE was 15.3% in Q4, helped partly by $489m of net benefit from credit provisions (after $851m of reserve releases).

Common Equity Tier-1 ("CET1") ratio was at 10.6% at Q4 2021, lower than prior periods because buybacks and dividends exceeded earnings in recent quarters. The average share count was 5.5% lower year-on-year.

For full-year 2021, BAC achieved a ROTCE of 17.0%, helped by $4.59bn of net benefit from credit provisions. Pre-Provision PBT was 3.1% lower than in 2020, primarily due to a lower NII; Non-Interest Revenues grew 9.5%, while Non-Interest Expenses grew 8.2%. Pre-Provision PBT was also 19.2% lower than in 2019, with the biggest factor being a $6.0bn difference in NII:

BAC Results Headlines (Reported Basis) (2021 vs. Prior Year)

img src="https://static.seekingalpha.com/uploads/2022/1/19/589751-16426377469757092.png" alt="BAC Results Headlines (Reported Basis) (2021 vs. Prior Year)" loading="lazy"">BAC Results Headlines (Reported Basis) (2021 vs. Prior Year)

Source: BAC results supplements.

More importantly, Q4 results show the operational drivers that we believe will help BAC maintain a ROTCE of 16% or higher in future years.

Management expressed similar confidence in BAC's ROTCE:

"We've always said that our job is to keep that well in excess of our cost of capital ... We'll continue to grow the earnings at returns that are used -- we used to say 10-12%, now I'd say, 15% - and we'll continue to do that ... last year, we had good ROTCE, and we expect to maintain that."

Brian Moynihan, BAC CEO (Q4 2021 earnings call)

Solid Q4 Net Interest Income Growth

BAC's NII grew 2.9% sequentially to $11.5bn in Q4 2021, though it remained 6.2% below the pre-COVID figure of $12.3bn in Q1 2020:

BAC Net Interest Income (Since Q3 2019)

img src="https://static.seekingalpha.com/uploads/2022/1/19/589751-1642639026216054.png" alt="BAC Net Interest Income (Since Q3 2019)" loading="lazy"">BAC Net Interest Income (Since Q3 2019)

Source: BAC results supplements.

The sequential NII growth was not due to an improvement in Net Yield on Interest-Earning Assets, which in fact dipped by 1 bps from Q4, and remained significantly lower than pre-COVID levels:

BAC Rates on Assets and Liabilities, and Net Interest Yield (Since Q3 2019)

img src="https://static.seekingalpha.com/uploads/2022/1/19/589751-16426398697143867.png" alt="BAC Rates on Assets and Liabilits, and Net Interest Yield (Since Q3 2019)" loading="lazy"">BAC Rates on Assets and Liabilits, and Net Interest Yield (Since Q3 2019)

Source: BAC results supplements.

The sequential NII growth was entirely due to loan growth. Excluding the Paycheck Protection Program ("PPP"), average BAC loans grew 3.4% between Q3 and Q4 (or 14% annualized) to $939bn:

BAC Average Loans & Leases (Since Q4 2020)

BAC Total Loans & Leases (Since Q4 2020)

Source: BAC results presentation (Q4 2021).

Including PPP, average loans grew 2.7% sequentially in Q4, accelerating from 1.4% in Q3 and flat in Q2. Loan growth was consistent through the quarter, and every category grew except the relatively small Home Equity:

BAC Average Loans & Leases by Category

img src="https://static.seekingalpha.com/uploads/2022/1/20/589751-16426715225162375.png" alt="BAC Average Loans & Leases by Category" loading="lazy"">BAC Average Loans & Leases by Category

BAC results supplements.

NII growth is expected to accelerate in 2022.

Higher Rates & Loan Growth To Help 2022

BAC's NII growth is expected to accelerate in 2022, with both rates and loan growth being material tailwinds.

BAC's balance sheet has historically been liability-sensitive, benefiting from rate rises because the rate on its liabilities rise slower and less than the rate on its assets. Management stated that a 100 bps parallel shift in the yield curve would increase its NII by $6.5bn (or 14% of its annualized NII) as of Q4 2021, compared to $7.2bn at Q3 and $10.5bn at the start of 2021:

BAC Estimated Book NII Sensitivity to Curve Changes

img src="https://static.seekingalpha.com/uploads/2022/1/20/589751-16426675821568847.png" alt="BAC Estimated Book NII Sensitivity to Curve Changes" loading="lazy"">BAC Estimated Book NII Sensitivity to Curve Changes

Source: BAC 10-Q filing (Q3 2021)

The forward yield curve is currently pricing in three Federal Reserve rate hikes of 25 bps each during 2022, which would benefit BAC significantly.

BAC also expects solid loan growth in 2022, in "high single digits" according to CFO Alastair Borthwick on the earnings call.

The combination of higher rates and loan growth means BAC is expecting significant NII growth in 2022:

"We expect to see robust NII growth in 2022 compared to 2021 ... In the first quarter specifically, we expect two headwinds [that]... add to about $250m. Despite those headwinds, we would still expect Q1 to be up about a couple of hundred million from Q4 and should grow nicely each subsequent quarter in 2022."

Alastair Borthwick, BAC CFO (Q4 2021 earnings call)

The two headwinds were two fewer interest accrual days in Q1 (to be recovered in subsequent quarters) and lower PPP fee benefits.

There is enormous potential in BAC's NII. Management highlighted how NII remains 9% below Q4 2018, despite average loans being 1% higher; BAC should also have a much larger loan book, as deposits are now nearly 50% larger and BAC is holding $673bn more in securities and cash:

BAC NII vs. Securities & Cash, Deposits and Loans

img src="https://static.seekingalpha.com/uploads/2022/1/20/589751-16426719468697655.png" alt="BAC NII vs. Securities & Cash, Deposits and Loans" loading="lazy"">BAC NII vs. Securities & Cash, Deposits and Loans

Source: BAC results presentation (Q4 2021).

For 2022, with loan growth to be a "high single digit" and a likely 75 bps or more increase in rates (spread throughout the year), we believe BAC's NII can potentially grow by 10-15% year-on-year.

Limited Decline In Non-Interest Revenues

Another reason we believe BAC's ROTCE can remain at 16% or above is that the decline in its Non-Interest Revenues will be relatively limited.

Sales & Trading and Investment Banking ("IB") revenues have been elevated industry-wide since the pandemic, as near-zero rates stimulated markets and corporate activity, and have started to trend down in 2021. BAC's Sales & Trading revenues fell again in Q4, though IB fees stayed high:

BAC Selected Non-Interest Revenues (Since 2017)

img src="https://static.seekingalpha.com/uploads/2022/1/20/589751-16426733516818156.png" alt="BAC Selected Non-Interest Revenues (Since 2017)" loading="lazy"">BAC Selected Non-Interest Revenues (Since 2017)

Source: BAC results supplements.

NB. "DVA" = "Debt Valuation Adjustments".

However, BAC's Sales & Trading and IB revenues in 2020-21 were only approx. $5bn higher than pre-COVID levels, and much of that increase was attributable to management deploying 20-25% more balance sheet in Global Markets in early 2021 after years of constraining its growth. We believe these revenues will normalize at a higher level than before the pandemic.

BAC will also see a headwind of approx. $1bn (75% in 2022) after its decision to phase out Non-Sufficient Funds fees and further reduce overdraft fees.

Together the above is likely to reduce Non-Interest Revenues by just over $5bn, which should be more than offset by the expected NII increases.

Good Expense Control To Continue

BAC earnings growth will be helped by operational leverage, as expenses continue to grow less than revenues.

Q4 2021 expenses grew only 2.0% from Q3 and 5.8% year-on-year, helped by lower COVID costs (though some remain) and further digital engagement:

BAC Non-Interest Expense (Last 5 Quarters)

img src="https://static.seekingalpha.com/uploads/2022/1/20/589751-16426747825225554.png" alt="BAC Non-Interest Expense (Since Q4 2020)" loading="lazy"">BAC Non-Interest Expense (Since Q4 2020)

Source: BAC results presentation (Q4 2021)

For 2022, management's "best expectation currently is we can hold expenses flat compared to 2021, which finished just below $60bn"; Q1 will have the usual seasonally-higher payroll taxes and revenue-related compensation.

Valuation: Is BAC Stock Overvalued?

At $46.44, BAC stock is trading at 2.1x Price / Tangible Book Value.

Relative to 2021 (and adjusted for buybacks), the P/E is 12.6x. Relative to 2019 figures (excluding First Data JV impairment), the P/E is a similar 13.2x.

BAC stock pays a dividend of $0.21 per quarter, or $0.84 annualized, representing a Dividend Yield of 1.8%. Management targets a Payout Ratio of around 30%, and the dividend was raised 17% (from $0.18) in 2021.

Share repurchases totalled $25.1bn in 2021, equivalent to 6.5% of the current market capitalization, and helped reduce BAC's CET1 ratio from 11.9% to 10.6%. (The minimum requirement is 9.5%, and management targets a 50-100 bps buffer.) Some earnings will be retained for organic growth.

Compared to our assumed long-term P/E of 14x, BAC stock is not overvalued.

Bank of America Stock Forecast 2025

BAC's 2021 EPS was 8.1% higher than our most recent forecasts ($3.30).

We raise our assumptions slightly and extend our forecasts to 2025:

  • ROTCE to be 16.0% for all years (was 14.0% in 2022 and 15.0% in 2023)
  • Net Income each year to be 15% retained for growth (was 10%), 30% paid out as dividends (was 40%) and 55% on buybacks (was 50%)
  • Buybacks to be carried out at a P/TBV of 2.1x (was 2.0x)
  • 2025 year-end P/E of 14x (unchanged)

Our new 2024 EPS forecast of is 0.7% higher than before ($4.02); our new 2024 TBV/share forecast is 1.6% higher than before ($25.54):

Illustrative BAC Return Forecasts

img src="https://static.seekingalpha.com/uploads/2022/1/20/589751-16426773289562297.png" alt="Illustrative BAC Return Forecasts" loading="lazy"">Illustrative BAC Return Forecasts

Source: Librarian Capital estimates

With shares at $46.44, we expect an exit price of $61 and a total return of 41% (9.4% annualized) by the end of 2025.

While this is slightly slower than the 10% we typically require, the optionality inherent in BAC's ability to benefit from further interest rate rises means we like the overall risk/reward, and we continue to rate BAC stock a Buy.

Is BAC Stock A Good Buy? Conclusion

Q4 results showed the operational drivers that will make it a key winner from 2022 rate hikes.

Loan growth accelerated to 3.4%, with every category growing except Home Equity, and is expected to be high single digits in 2022.

Interest income will grow $6.5bn if rates rise 100 bps, while the impact from lower markets and corporate activity should be limited.

Expenses grew a modest 2.0% from Q3, and management expect to hold them flat in 2022, allowing strong operational leverage.

With shares at $46.44, we expect a total return of 41% (9.4% annualized) by the end of 2025. The Dividend Yield is 1.8%.

We reiterate our Buy rating on Bank of America Corporation stock.

Source : https://seekingalpha.com/article/4480534-bank-of-america-strong-q4-earnings-benefit-2022-rate-hikes

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