Last week, Warren Buffett’s favorite bank, Bank of america (NYSE: BAC), reported its third-quarter earnings. Even in difficult times, the results revealed why the infamous risk-taker Buffett loves it so much.
Despite the pandemic, Bank of America has actually been profitable every quarter this year despite large loan reserves that easily cover its dividends. Moreover, CEO Brian Moynihan gave investors even more cause for optimism, declaring that the bank is unlikely to pass up the worst effects of the pandemic on not just one, but several points.
Net interest income
For example, Bank of America is very sensitive to interest rates, perhaps even more so than its other major capital banks. During the pandemic, banks had to deal with a double storm of headwinds related to net interest income (NII), which is the spread between interest earned on loans and interest paid to depositors.
First, during the pandemic, consumers became conservative, paying down loans and taking out fewer loans in general, while injecting more cash into deposits. Second, interest rates fell, which means that new loans were granted at lower interest rates than loans that were repaid. Mortgage borrowers took advantage of paying off their mortgages early and refinancing with lower interest rate products.
The combination led to the NII in Bank of America falling 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 the decline in NII is behind the company for four main reasons. First, management on commercial and industrial (C&I) revolving loans is slowly looking back to using C&I revolvers when the economy bounces back. Second, as with commercial lines, Bank of America sees credit card activity bounce back, which should lead to higher credit card balances, especially as we enter the holiday trading season. Third, the long end of the yield curve has “stabilized,” or it has stopped going down, and management believes mortgage buyers may have some “refinancing fatigue” after huge refinancing levels over the summer. Finally, Bank of America is happy to invest more in mortgage bonds compared to having more cash, which it did in the spring and summer.
The payment activity has actually become positive year over year
Moynihan also noted that while GDP had recovered to 90% -plus from where it was last year in the third quarter, Bank of America customers were already back to spending more in September 2020 versus September 2019, and that customer spending in October was running about 10% above the 2019 level. This is despite stimulus payments declining as benefits expired in the last quarter.
In addition, Bank of America, what will be music to Buffett’s ears, built only $ 417 million in additional loan servers in the last quarter, compared to as much as $ 3.6 billion in the first quarter and $ 4.0 billion in the second quarter, suggesting on the fact that the bank is now almost fully reserved for a potential worst-case scenario as a result of the COVID-19 pandemic.
And unbelievably, net-offs indeed rejected from the second quarter. If depreciation surprises by being less severe than expected, Bank of America could see a release of its reserves in the future. There are still very uncertain things on this front. Moynihan noted in the conference call with analysts, “we expect the reserve buildings to be behind us, which means P&L [profit and loss] the impact of these losses should already be in our economy. ”
Management also expects it to be past the worst of its increased coronavirus-specific expenses. These entail not only security 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 that offsets them, but the total cost drove non-interest expenses around $ 1 billion. $ Higher in last quarter.
Management still expects total non-interest expenses to fall from DKK 14.4 billion. Last quarter to 13.7 billion. $ Next quarter as the company turns the corner against coronavirus.
A cheap and low-risk bank
While Bank of America’s performance showed a 9% drop in earnings compared to the quarter last year, it was not nearly as bad as some of the bank’s peers. This is particularly impressive as it depends predominantly on lending and does not have as much exposure to sales and trade or investment banking as some other banks (although it does have some).
With an excellent balance sheet, low-risk loan book, earnings still covering its dividends, and Moynihan says the worst is over for the bank on many fronts, Bank of America looks like perhaps the safest value in the banking sector at just 0.9 times book value and 12 times expected earnings.