Bank of America's 2023 Plunge: Beyond the Surface

Bank of America Corp. (BAC, Financial), the second-largest bank by assets in the U.S., saw its stock plummet by approximately 18% in 2023.

Surprisingly, this drop contrasts with its U.S. megabank peers, who have managed to hold steady or even see modest gains. The reasons for the selloff are rooted in the broader banking crisis this past spring, but there is more to the story.

Many attribute this unease to the short-lived banking crisis in March. The landscape for Bank of America altered drastically following this episode. Investor anticipation around funding costs morphed, and there was a shift in the perspective on examining bank balance sheets.

Why are investors hesitating?

In 2023, despite favorable circumstances for banking, the sector experienced significant turbulence. The chaos that unraveled in March with bank runs at SVB and Signature Bank sent shockwaves through the industry. Though initial panic has since diminished, stock investors remain wary as the crisis can be traced back to two main challenges.

The first is skyrocketing interest rates. With the Federal Reserve's sharp interest rate hikes, bond portfolios felt the heat, leading to declining values.

Second was decreased deposits. High interest rates, amplified competition and quantitative tightening meant reduced deposit levels. Banks were forced to offload bonds at losses to make up for the deposit outflows.

Bank of America's predicament

Despite its strength and resilience, Bank of America was aware of these challenges. Prior to the Federal Reserve's aggressive rate hikes in 2022, the bank made considerable investments in low-yielding, long-term bonds. This decision backfired by the first quarter of this year as it announced over $99 billion of unrealized losses in its held-to-maturity bond portfolio.

However, these challenges might be the visible part of a larger, concealed iceberg. There are some signs that suggest Bank of America's stability might not be as rock-solid as perceived. Recent audits indicate a need for alignment between the bank's financial statements and the Federal Reserve's computations. Also, the bank is still grappling with the repercussions of the liquidity crisis the sector faced earlier this year.

The silver lining

Under the visionary leadership of CEO Brian Moynihan, Bank of America has emerged as one of the premier banks globally. Its impressive asset portfolio, stellar credit quality and significant technological investments position it uniquely in the industry. The bank has shown commendable resilience and adaptability despite hurdles like Brexit, Covid-19 lockdowns, and the current interest rate cycle.

The bank's second-quarter earnings report paints a brighter picture. With an earnings per share increase of 21% year over year and a net income rise of 19%, there are evident strengths in its financial health. Such robust results, especially in an inflationary environment, speak volumes about the management's understanding.

Bank of America witnessed a rise in deposits exceeding loans, growing from $500 billion in the fourth quarter of 2019 to $1.1 trillion by the first quarter of 2022, predominantly stored as cash and investment securities. As of June 30, $800 billion in excess deposits remained, with 54% in held-to-maturity investments. The bank's deposit approach starkly contrasts with fringe banks, which suffered due to imprudent strategies.

The company's second-quarter deposits stood at $1.87 trillion, a slight decrease from prior periods. A significant portion of these deposits represents core operations, making them stable. Shifts towards higher-yielding options have raised costs, yet deposit betas remain resilient, ensuring stability for significant banks like Bank of America.

Source: BAC earnings presentation

While the upcoming quarter may see more deposit pressure, it is a transient issue. Once stabilized, Bank of America's unparalleled deposit base and banking fortresses will continue to stand tall. From a valuation standpoint, its stock trades at a little above 8 times forward earnings and 0.86 times its book value, suggesting an appealing entry point.

Strengths keeping Bank of America afloat

Bank of America is not just a national giant; its reach is global, with a presence in over 35 countries. This vast network offers a diversified revenue stream, tapping into various international markets. Despite the challenges, the bank has consistently grown, building a trust reservoir among its investors and customers.

Innovation is at the bank's forefront, showcased when Fortune magazine crowned it the "Most Inventive Bank in North America" in 2020. The brand's solid reputation, extensive ATM and branch network and robust digital platform further cement its position in the banking sector.

Potential weaknesses

However, like all companies, Bank of America has its vulnerabilities. Lawsuits and controversies mark its history. For instance, the hefty settlement of around $16.65 billion in 2014 for not revealing mortgage-related costs stands out. Most of its revenue is sourced from the U.S., making it sensitive to the nation's economic fluctuations and regulatory changes. Competition from fintechs, traditional banks and other financial service providers is fierce, posing a significant challenge.

In conclusion, while Bank of America faces several challenges and red flags, viewing its trajectory with a balanced perspective is essential. The bank's inherent strengths, established trust and significant market share must be noticed. Current owners may see no reason for divestment, but potential investors need to tread with caution, making sure they are not drawn in by the allure of a stock that, at this moment, seems cheaper than it should be.

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