On Bank of America Corp. (NYSE: BAC) and target price of $30 following the company’s 3Q results. The quarter included some recurring themes from 2Q, such as interest margin contraction (as lower rates take hold), but also a lower credit loss provision as reserves for projected delinquencies have already been built in. In addition, card income rose 7% from the prior year as consumer spending rebounded from a weak 2Q. Still, we expect continued pressure on revenues (from margin contraction) to keep earnings below recent levels in the near term.
Looking beyond near-term challenges, management continues to focus on what it terms ‘responsible growth.’ We believe this may be seen in the company’s ability to expand its loan portfolio without taking on too much credit risk, and to maintain balanced growth across segments so that more volatile businesses, such as trading and investment banking, do not account for an outsized portion of profits.
We believe that the current BAC share price undervalues the franchise, and are maintaining our target price of $30.
Net revenues were down 11%, to $20.3 billion, as lower net interest income from a narrower net interest margin was partly offset by greater investment banking and credit card revenues.
Net charge-offs were 0.40% of average loans, up from 0.34% a year earlier. With $972 million of net charge-offs and a $1.4 billion loan loss provision, there was a significant reserve build as the company prepared for pandemic-related credit losses.
Noninterest expenses were $14.4 billion, down 5% from the prior year, and pretax income declined 34% to $4.9 billion.
EARNINGS & GROWTH ANALYSIS
Bank of America has four operating segments: Consumer Banking, Global Wealth and Investment Management, Global Banking, and Global Markets. Third-quarter results by segment follow below.
In Consumer Banking, 3Q pretax income was down 38% to $2.7 billion, hurt by a contraction in the net interest margin due to lower interest rates, and a 10% rise in expenses to support customers and employees during the pandemic. Consumer investment assets rose 20% to $267 billion, reflecting substantial client inflows and market appreciation. High unemployment is expected to continue to weigh on results in this segment.
In Global Wealth and Investment Management, pretax income fell 32% to $992 million. Revenues decreased 7%, as lower net interest income more than offset higher AUM. Operating expenses were up 3%, and the segment pretax margin slipped to 22% from 30%. Client balances were up 6%, to $3.1 trillion, aided by inflows. While weaker economic conditions are affecting near-term results, we expect BAC’s focus on this segment to lead to stronger, less volatile earnings going forward, and continued improvement in the pretax margin.
In Global Banking, pretax income fell 56%, reflecting a sharply higher loan loss provision due to reserve building, particularly for the travel and entertainment industries. Revenue fell 13%, as lower net interest income outweighed higher investment banking fees, while operating expenses were up 7%.
In Global Markets, pretax income fell 2%, as a 16% increase in operating expenses more than offset a 10% increase in revenue (driven mostly by higher sales and trading, investment banking and card income).
For 2020, we now look for a 6% decline in revenue, on reducedloan volumes as customers delay purchases, contracting margins from the Federal Reserve’s rate cut campaign, and a weaker final quarter for investment banking. Offsets should include strong trading revenues as customers engage in substantial portfolio repositioning.
Full-year results will face pressure from higher credit loss provisioning as business shutdowns due to the coronavirus result in lost revenues and widespread layoffs. BAC management expects U.S. unemployment to remain high into 2021.
FINANCIAL STRENGTH & DIVIDEND
BAC is Medium-High. The company has been building capital in recent years through asset sales and intentional run-off, and through the reduction of legacy exposures in its investment banking business.
The company’s Tier 1 ratio under the Basel III Advanced Approach (fully phased-in) was 12.7%.
MANAGEMENT & RISKS
Paul Donofrio is the CFO.
The company owns about $450 billion of U.S. consumer loans, and is thus broadly exposed to the health of the U.S. economy and housing market. Its total loan portfolio is about $1 trillion. With regard to expenses, BofA spent heavily on legacy asset servicing following the mortgage crisis, though these costs have been falling steadily.
The company is primarily a U.S. retail and commercial bank, with a network of more than 4,000 branches across much of the country. The 2005 acquisition of MBNA made Bank of America the nation’s largest credit-card lender. BofA became a top-tier securities firm and retail broker with the acquisition of Merrill Lynch.
BAC shares have traded between $18 and $36 over the past year, and are currently in the lower half of that range. Near-term earnings are expected to be hurt by a range of issues related to the pandemic, including lower revenues from lending and other fee-based businesses, and sharply higher credit loss provisions. Still, we note that earnings quality for the franchise had been improving prior to the pandemic, and believe that recent investments will lead to stronger underlying earnings power once the coronavirus impact passes. While we believe the dividend is secure and capital levels are sound, capital returns will decline in 2020 as the company conserves capital.
Looking beyond near-term earnings challenges, we believe that BAC shares, trading at 11.3-times our revised 2021 EPS estimate and at a historical discount, remain attractively valued.