CA - Bank of America Beats Earnings Expectations Again

Summary

• Bank of America Corporation just released its fourth quarter earnings and beat on both revenue and EPS.
• The release showed rising net interest income and slight increases in earnings.
• I've been bullish on Bank of America for over a year, and this release does not change that opinion.
• In this article, I outline my reasons for being bullish on Bank of America stock, with a particular focus on the Q4 earnings release.

Bank of America Corporation ( BAC ) just released its fourth quarter earnings and beat expectations. The release was a beat on revenue as well as on EPS. In the quarter, we saw a big jump in net interest income, likely due to the 7.2% increase in credit card spending that was reported by credit card companies prior to the release. In light of the credit card report, I was not surprised that Bank of America beat expectations, though the size of the beat impressed me.

Interestingly enough, Bank of America actually dipped considerably pre-market after it announced its earnings. It could be that sector-wide selling impacted BAC. JPMorgan Chase ( JPM ) and Wells Fargo ( WFC ) released earnings at around the same that BAC did; Wells Fargo missed on revenue and JPMorgan announced a big increase in planned expenses. Bank of America was down the least of the three at the time of this writing, so perhaps it was merely a victim of sector momentum. The important point is that Bank of America itself put out a great release.

I've been bullish on financials, in general, this year because banks can benefit from high-interest rates. When rates go up, banks increase the rates they charge on variable rate mortgages/loans, and collect higher interest income. This effect isn't foolproof, mind you. An inverted yield curve can squeeze lending margins, and high rates won't even boost revenue if they cause a severe recession that leads to mass defaults. However, there is at least the potential for banks to gain from rising interest rates, and we've seen that in Bank of America's last few earnings releases.

In this article, I'll outline a bullish thesis on Bank of America stock. Starting with the fourth quarter earnings release, I'll move on to the bank's long-term advantages, its 2023 prospects, and finally its valuation. I'll conclude by sharing some risks that investors in the stock will have to keep in mind.

Earnings Recap

In the fourth quarter , Bank of America delivered:

• $24.5 billion in revenue, up 11% (a beat).

• $7 billion in net income, up 1.42%.

• $0.85 in diluted EPS, up 3.65% (a beat).

• $9 billion in pre-tax, pre-provision earnings, up 23%.

• $1.1 billion in investment banking fees.

It was a very strong showing. In the quarter, we saw Bank of America profit off of rising interest rates yet again, despite the yield curve inversion observed in the period. Generally speaking, inverted yield curves are thought to be bad for banks, because they borrow on the short end and lend on the long end. In 2022, term deposit interest increased, but savings account interest barely did so. On the whole, banks benefitted from the higher rates, as shown in BAC's large increase in net interest income.

What's Coming in 2023?

Having looked at Bank of America's final 2022 quarter, we can now look ahead to what's coming in 2023.

Bank of America itself expects the macroeconomic picture to be troubling. It raised PCLs (reserves set aside for underperforming loans) by $403 million and used the phrase "dampened macroeconomic outlook" five times in its press release. It appears that investors are betting on tough times for the big banks in 2023.

However, that's far from a foregone conclusion. Remember that regulators require that banks be prudent in their estimates. After the 2008 financial crisis, regulators convened to create the Basel III framework , upping capital requirements in an effort to prevent another crisis. Today, they're working on Basel IV , which will up the requirements even further.

So, the fact that Bank of America has a dampened macroeconomic outlook does mean that it, as an individual bank, will do poorly. On the contrary, there are reasons to believe it will do well.

First, it has become clear at this point that high interest rates are dominating yield curve inversion as a driver of net interest income. Q4 was the second quarter in a row when NII went up more than 20%: obviously, the sheer speed of the rate hikes has overwhelmed the fact that the yield curve inverted.

Second, the consumer is still strong. As mentioned previously, Mastercard ( MA ) said that credit card spending increased 7.2% in Q4. BAC's credit card earnings were consistent with that, and there's little reason to think this will reverse in 2023, as the labor market is still strong.

There is a general consensus that the U.S. economy will enter a recession in 2023, but a consensus forecast is still just a forecast. Current economic conditions are strong. Given this, and given the fact that Bank of America's interest income is rising 29% year-over-year, I would expect overall earnings growth of at least 20% next year-maybe 30% if the recession doesn't happen and BAC can release some reserves.

Long-Term Advantages

Looking ahead past 2023, we can see that Bank of America has several long-term advantages. It has strong brand recognition. It has a more than adequate 11.2% CET1 ratio. Finally, with a large investment banking division, it could benefit if the Fed finally pivots in 2024 . Right now, investment banking is holding back bank earnings, but that could reverse in a big way when M&A and IPOs come back to life. Should the Fed pivot, the odds of that happening will increase, so it may help to take positions in banks like BAC that have exposure to investment banking.

Valuation

Now for my favorite aspect of Bank of America: the valuation.

BAC is a rather cheap stock going by usual valuation metrics. According to Seeking Alpha Quant , it trades at:

• 10.9 times earnings.

• 3 times sales.

• 2.92 times sales.

• 1.15 times book value.

• 37 times operating cash flow.

Apart from the cash flow multiple-which isn't always the most relevant metric for banks-these are rock bottom multiples. Now, BAC scores only a "D+" on value on Seeking Alpha's Quant system, but remember that these are sector-relative grades. Among banks, you'll find bargains like Bank of Montreal ( BMO , BMO:CA ) trading at 9 times earnings - BAC looks a little pricey compared to that. However, it is also a high-quality bank with entrenched relationships in the financial sector and a physical presence in many states. It deserves a premium to its sector, and at any rate, it is cheap compared to the average S&P 500 stock .

Risks and Challenges

As we've seen, Bank of America is a cheap stock and a thriving company. It has a lot of things going for it and is worth owning. However, it is not without its risks and challenges. Some of the most important include:

• Yield curve inversion. Inverted yield curves are thought to be bad for banks because they borrow on the short end of the yield curve and lend on the long end. In practice, it is mostly term deposits whose interest increases when short-term rates go up: banks don't really pay much interest on savings accounts even when the Fed tightens. Still, yield curve inversion is in principle a risk to watch out for. Imagine that tomorrow, JPMorgan and Wells Fargo announce they're hiking savings account interest to 3%. If they did that, they BAC would have little choice but to do the same; it would lose clients otherwise.

• Recession. If a recession occurs, it will likely be bad for Bank of America. In the immediate term, BAC will have to raise PCLs to prepare for the coming defaults, which will cause on-paper earnings to go down. In the longer term, the bank may in fact see a rise in defaults, in which case the merely "on-paper" losses from PCL build will transform into actual cash-flow losses.

• Continued weakness in investment banking. As we saw in the fourth quarter, Bank of America's investment banking fees fell dramatically. Down 54% year over year, they put a significant dent in results. Investment banking in general has been doing poorly over the last year. Part of the reason is that tech IPOs aren't really happening anymore , another reason is that general M&A is down. Recently, we heard that Microsoft ( MSFT ) would be investing $10 billion into OpenAI. This could be a good sign that M&A in the tech sector is coming back, but on the whole, investment banking weakness remains a risk to watch out for.

The Bottom Line

The bottom line on Bank of America Corporation is that it is a highly profitable bank whose earnings just easily surpassed expectations. As usual, growth in net interest income was strong, while rising credit card spend and high interest rates added to the comparatively solid BAC performance. The current environment, with its high interest rates, generally favors bank stocks. Most of the big U.S. banks probably have a solid year ahead of them, but Bank of America Corporation is doing a little better than the average one. I added heavily to my Bank of America position last year, and I have no plans to stop this year. Bank of America Corporation definitely is a solid pick to consider for 2023.

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