Last week, Warren Buffett’s favorite bank, Bank of America (NYSE: BAC), reported earnings in the third quarter. Even at trial times, the results revealed why he was known for the well-known exploitative risk that Buffett disliked.
Despite the pandemic, Bank of America is actually earning quarterly this year despite its large loan reserves, which immediately cover its dividend. Moreover, CEO Brian Moynihan gave investors more reason for optimism, declaring that the bank is likely to go beyond the worst effects of the pandemic on not one but many respects.
Net interest income
For example, Bank of America is very sensitive to interest rates, perhaps even to a higher degree than other large-cap banks. During the pandemic, banks will have to deal with a double whammy of headwinds associated with net interest income (NII), which spreads between interest earned on loans and interest paid on depositors.
First, during the pandemic, consumers became conservative, repaid loans, and took out fewer loans in general, while spending more money on deposits. Second, interest rates plummeted, which means new loans are made at lower interest rates than loans paid off. Take advantage of mortgage lenders, repay their home loans in advance and refinance at lower rates products.
The combination led NII to Bank of America to decline from $ 12.27 billion in the first quarter to $ 10.98 billion in the second quarter and $ 10.24 billion in the third quarter.
However, management now believes that NII denials are behind the company for four main reasons. First, with commercial and industrial (C&I) revolving loans, management sees companies slowly return to using C&I revolvers as the economy grows. Second, as in the lines of commerce, Bank of America sees credit card activity return, which should lead to higher credit card balance, especially as we enter the holiday shopping season. Third, the long end of the yield curve “stabilizes,” or stops it from falling, and management thinks mortgage buyers may have some “stress re-financing” after a large level of tag refinancing -day. Finally, Bank of America feels good about investing more in mortgage-backed securities compared to handling more money, which it does in spring and summer.
Payment activity has really been positive year after year
Moynihan also noted that while GDP recovered 90% -plus where last year in the third quarter, Bank of America customers have returned to spending more than September 2020 compared to September 2019, and spending customer in October is running at almost 10% above the levels of 2019. This is despite the stimulus payment that disappears when benefits expire last quarter.
In addition, to what will be Buffett’s ear music, Bank of America built just $ 417 million on additional loan reserves last quarter, compared to a whopping $ 3.6 billion in Q1 and $ 4.0. billion in Q2, indicating that the bank is now almost exclusively destined for a potentially worst situation resulting from the COVID-19 pandemic.
And fantastic, net charge-off really denied from the second quarter. If the surprise of the charge-offs by being less severe than expected, Bank of America could see the release of its reserves in the future. However, things are quite uncertain on this front. Moynihan said in a conference call with analysts, “We expect the reserves to be behind us, which means P&L [profit and loss] the impact of losses should be on our finances already. ”
Management also expects beyond the worst of coronavirus-specific costs. Those not only require safety measures but also increased processing costs for unemployment claims, as well as processing costs for Paycheck Protection Program (PPP) loans. . Both of these costs have some revenue moving them, but overall costs have pushed up non-interest costs of approximately $ 1 billion in the past quarter.
However, management expects overall non-interest costs to fall from $ 14.4 billion in the previous quarter to $ 13.7 billion in the next quarter, as the company revised the coronavirus.
A cheap and low risk bank
While Bank of America results showed a 9% decline in revenue compared to last year, it was not so bad for some bank colleagues. This is especially impressive because it depends largely on lending and there is not much exposure to sales and trading or investment investing like some other banks (even if it has).
With a good balance sheet, low-risk debt book, still income covering its dividend, and Moynihan said the worst done for the bank in many facets, Bank of America looks like the safest value in the banking sector, at just 0.9 times the book value and 12 times expected earnings.