The operating environment of the past few quarters has been a pretty good one for lenders. Rates have risen sharply, credit demand has been strong, and asset quality, though normalizing, has likewise remained solid.

That makes Bank of America’s (BAC) relative underperformance all the more frustrating. Shares of the Charlotte-based giant are off by 8-15ppt versus peers JPMorgan, Citi and Wells Fargo since the start of last year on a total return basis, and by around 7ppt versus the broader Dow Jones U.S. Bank Index over the same period. The latter does at least make some sense to me: fee-based income being something of a dead weight recently, even if that is more a function of strong comps. Still, Bank of America is more of a lender than, say, JPMorgan, yet has trailed it by around 12ppt since the start of 2022.

That the above may be a sign of a more challenging macro environment is a real near-term consideration, but for those with a longer-term disposition I’m inclined to think that this represents a decent opportunity. There is a lot to like about Bank of America. It has the #1 domestic deposit share, has diverse revenue lines in fee income, and has the firepower to spend on things like tech that could see it grab share steadily over the long run. The stock isn’t ridiculously cheap, but with a sustainable 14-15% ROTE on the table it does have a nice blend of quality and value going for it, and for long-term investors that usually makes for a good combination.

Strong NII Performance Offset By Weaker Guidance

It might seem strange to say that there were some sour notes regarding net interest income last quarter, as leverage to higher interest rates was (and remains) one of Bank of America’s big draws.

With that, Q4’22 NII was $14.7b ($14.8b on a FTE basis), an increase of around $3.3b year-on-year and $1b sequentially. Full-year net interest income of $52.4b was up around $9.5b on 2021, with that coming as a function of higher yields, volume and mix shift. Q4 net interest yield of 2.81% (excluding the Global Markets division) was up almost 90bp year-on-year and 30bp sequentially.

Earning assets rose a little over 3% to $2.7t in 2022 on an average balance basis, with loans & leases up 10% to $1.02t. Within that, average Q4’22 credit card balances of $89.5b represented year-on-year and sequential growth of 14% and mid-single-digits respectively, while U.S. commercial real estate loan balances increased 3% sequentially to $68.8b. Residential mortgage growth was understandably softer, with sequential growth dropping to a virtual standstill in Q4.

Guidance is perhaps where the ball was fumbled. Implied Q4’22 NII of around $15b provided in Q3’22 commentary was downgraded toward the end of last year, and that may go some way to explaining the recent underperformance quoted above. Likewise, FY’23 NII guidance was arguably a tad woolly and definitely weaker than many analysts expected. Funding is something to keep a close eye on; NIB deposit balances were down 8% sequentially to a little over $680b in Q4’22, with total deposits down 2% on the same basis.

Whether the market’s reaction is fair or not is a different question, and one that long-term investors may not even care about, but up-and-down guidance is the kind of thing that this hyper-short-term-looking world doesn’t like.

Fee Income, Provisioning Leads Headline Numbers Lower

Bank of America’s fee income franchises form a key plank of the long-term investment case, but with those lapping strong comps it is the banks that are dependent on spread income that have been at an advantage recently.

Non-interest income for the full year was circa $42.5b, a fall of around 8% on 2021 levels. Q4’22 performance was similarly soft, also declining by high single-digits (to $9.9b) on both a sequential and year-on-year basis. Investment banking fees were particularly weak, falling by around 45% for the full-year (to $4.8b) and by over 50% in Q4’22 on a year-on-year basis, while Wealth Management fees declined another 1.5% sequentially, albeit higher NII more than made up for that.

I don’t want to dwell on this too much given the nature of the comp, and there were actually a few bright spots here. The bank’s market share in investment banking moved up a spot (from #4 to #3) despite the steep drop in fees, while Sales & Trading income is coming in strong. By my count total non-interest income is 3-4% below pre-2020 levels, and with that coming on the back of very weak IB fees I do think this is a solid long-term base from which to push on from.

On provisioning, bad debt expensing has been ticking up on a sequential basis for a while as credit quality inevitably returns to more normal levels. The Q4’22 figure of $1.1b represents a cost of risk more in line with pre-2020 levels, while the full-year PCL expense of $2.5b was around $7b higher than last year’s release and explains the headline year-on-year fall in net income and EPS.

The Outlook

Looking ahead, Bank of America remains very asset sensitive, with the latest disclosure seeing a 100bp parallel shift in the yield curve lifting annual NII by 6-7%. NII guidance was a tad vague, and though I believe the implied FY’23 figure of around $57.5b was worse than many analysts expected it would still represent year-on-year growth of over 9%.

The big worry of course is that the all-round environment is now getting more challenging. Management is pencilling in mid-single-digit loan growth this year, which could end up too high if things deteriorate worse than expected. Funding costs coming in worse than expected is likewise a potential risk to NII, and there is perhaps more uncertainty now on deposit performance. Expectations for more (and harder) rate hikes have also moderated.

I am not too concerned on credit quality, though obviously in a nasty recession this would weigh heavily on net income. The bank is already provisioned for a mild one, and with pre-provision operating income of over $33b I believe it could absorb a bad one relatively comfortably. I would see a serious downturn as more of an opportunity to load up rather than as a big area of concern.

The Q4’22 net charge-off ratio of 26bp, though another 6bp higher sequentially, remains 12bp below 2019 levels, and that was a very good year for credit quality. Similarly, credit card delinquency rates are now inching up at a faster pace but also remain below 2019 levels.

While risk may be shifting to the downside, there are still things to like here, one of which is the bank’s operating leverage. Management was approving of the 62.5% FY’23 overhead ratio quoted by analysts, implying nicely positive jaws this year.

With that, I’m pencilling in net income of around $28b for FY’23, or around $3.60 per share. The mid-term outlook of moderate expense growth should, assuming the bank realizes it, be a nice tailwind for earnings growth for a few years to come.

What Does The Market Think?

Bank of America shares change hands for $33.46 apiece at time of writing, putting them at just under 1.55x tangible book value per share and around 10.5x and 9.3x FY’22 EPS and my FY’23 EPS estimate respectively.

I value banks like this using a modified dividend discount model and on a P/TBVPS basis. On the latter, I think Bank of America should be good for an average ROTE in the 14-15% area, so I do see some upside from its current multiple.

Under the modified dividend discount model, the market seems to be pencilling in long-term growth in the 1-1.5% per annum area, which strikes me as a tad conservative. That’s based on the current share price, a 9% hurdle rate and my view of the bank’s sustainable payout ratio (around 80% based on its ROTE profile). Bumping growth by 1-1.5ppt gets me to a fair value in the $40-41 per share region.

Summing It Up

I think Bank of America is in an interesting spot for long-term investors, notwithstanding the weakening near-term outlook. This isn’t the cheapest of the big money center banks – that distinction belongs to Citi – and nor is it the highest quality, with JPMorgan the pack-leader on that measure. Having said that, this stock doesn’t come with the “warts and all” qualifier that Citi does, while JPMorgan’s premium quality is arguably well reflected in its price. Bank of America lands somewhere in the middle, then: solid on quality while not especially expensive. And for long-term investors that’s usually a good combination to have.

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