Bank Of America: Now Is A Great Time To Buy This 3% Yielder (NYSE:BAC)

The banking sector continues to be challenged in the current macroeconomic environment. While there are likely more questions than answers in the near term, I do believe that this presents good buying opportunities for those with a medium- to long-term outlook. In this article, I’m focused on Bank of America (NYSE:BAC), whose share price has largely underperformed the market, with a 31% decline since the start of the year. I evaluate what makes Bank of America an attractive buy at the current price, so let’s get started.

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A Look Into Bank of America

Bank of America is perhaps one of those companies that doesn’t need an introduction. As the second-largest U.S. money center bank by assets, it has a leading presence in nearly all markets in the country. BAC ranks first in consumer deposit market share and ranks second in retail mortgages, small-business lending, and has a solid presence in corporate banking. It also has a strong retail brokerage and wealth management arm through Merrill Lynch, and is a top 5 global investment bank. Given these characteristics, I see BAC as having a strong moat-worthy brand and business model.

What draws me to BAC is its leading presence and the durable nature of the banking industry. While I do have sufficient exposure to technology stocks, I see the banking industry as being less vulnerable to the so-called “creative destruction” that tech companies constantly face. While the industry may have ups and downs, the key players largely remain the same, with BAC being at the forefront.

The current downturn has been challenging for BAC, as reflected in its Q3’20 results. EPS was $0.51, representing a 32% YoY drop. However, I’m encouraged to see that EPS increased by 38% on a sequential, QoQ basis. One of the key factors to the YoY decline in EPS was the drop in net interest income, which, as seen below, dropped to $10.2B during Q3.

(Source: Q3’20 Earnings Presentation)

This was the result of the net interest yield (excluding Global Markets) dropping to a near-term low of 1.72%, leading to declines in mortgage rates, and what management deemed as an “extraordinary” level of mortgage prepayments through refinancing activity. Plus, BAC was unable to completely offset the drop in NII, as interest rates on deposit balances were already near rock bottom.

(Source: Q3’20 Earnings Presentation)

On the bright side, however, average consumer banking deposits continued to grow, as it reached $861 billion at the end of Q3. This represents an impressive 20% increase since the end of 2019. I see this as being a strong future growth generator, as it gives BAC more lending firepower as economic activity resumes.

In addition, I see the bank’s IT investments as paying off, as BAC’s digital engagement grew strongly while much of the country was locked down. Average user logins were up 5% YoY, and Merrill Lynch’s digital platform has seen record logins on a YTD basis, with 95M logins. I see BAC’s robust IT platform as giving it a leg up against small- and medium-sized competitors. This viewpoint is also supported by Morningstar, which noted the following about BAC in its October research report:

“Given the new phase of banking we are entering, where technological changes are occurring faster and are more impactful than ever before and can be deployed across singular, integrated platforms, we see potential advantages for the largest banks when it comes to operating efficiency. With its tech budget of roughly $10 billion per year, Bank of America may not drop to the lowest overall efficiency ratio among peers, but it will be able to maintain higher levels of investment at similar efficiency levels. Further, with its solid mix of fee income, Bank of America will be better insulated if rates decline as it is less dependent on rate-sensitive net interest income.

Meanwhile, I’m encouraged to see that net charge-offs and consumer deferrals have trended down. As seen below, Q3 net charge-offs have trended down to near Q4’19 (pre-COVID) levels, and consumer deferrals amounted to just $9M, which is equal to the March level. As such, the reserve build expense has declined on a QoQ basis as well to $972M in Q3.

(Source: Q3’20 Earnings Presentation)

Looking forward, I expect inflation to creep back up as a result of the record amount of stimulus already provided, and with another round on the table. This is supported by an Oct 14th CNBC article, in which economic forecaster Lakshman Achuthan remarked that trends point to inflation comeback that’s pervasive and persistent. While the Fed Chairman expects interest rates to remain low until 2023, interest rates could start trending up after that, especially if inflation makes a comeback. The potential for higher interest rates could give BAC’s profits a strong boost.

Meanwhile, I find the shares to be attractively valued. At the current price of $24.24, the shares are trading at a 14% discount to the 28.33 book value. In addition, book value increased by 3.7% since the end of 2019, and at that time, the shares were trading at 29% premium to book value.

Lastly, I see the management as being shareholder friendly. Since 2015, total shares outstanding have been reduced by 16.5%. BAC also continued to out-earn its $0.18 dividend, with a 35% dividend to Q3 earnings payout ratio. As such, I find the 3% dividend yield to be attractive, especially in this current low-yield environment. While share buybacks and dividend growth won’t be happening in the near term due to restrictions from the Federal Reserve, I expect them to return after the economy gets on more solid footing.

Investor Takeaway

Bank of America has its share of headwinds during the current recession. Net interest income has been challenging, and I expect for that to continue in the near term. However, I’m encouraged by the continued growth in the deposit base. In addition, I expect the increased digital engagement and BAC’s robust IT platform to help improve operating efficiency down the line. Lastly, the record amounts of stimulus could result in inflation making a comeback. This would cause interest rates to reverse higher, and thereby improve BAC’s profitability.

I find the shares to be attractively valued at the current price of $24.24, with a blended P/E of 12.4 and a 14% discount to book value. Bank stocks are cyclical, and I see BAC’s current valuation as being at or near the low point of the current economic cycle. For this, and the reasons stated above, I believe now is a great time to buy this moat-worthy bank stock.

(Source: F.A.S.T. Graphs)

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Disclosure: I am/we are long BAC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.

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