A few months ago, no one could have foreseen how bad the first quarter earnings numbers of Bank of America (BAC) would become, and even more how large the uncertainty on notably the second quarter earnings report and the remainder of the year would be.
Contrary to some other big banks which traditionally report in the same week, including a premier name like JPMorgan Chase (JPM), is that shares have now fallen convincingly below book value, although still trading above the tangible book value per share.
The First Quarter Numbers
Bank of America reported first quarter sales of $22.8 billion, down slightly from the $23.0 billion number reported in the first quarter of 2019, yet up a bit from the $22.3 billion number in the final quarter of last year.
Net earnings of $3.5 billion were essentially cut in half from the $6.8 billion net profit number posted in the fourth and first quarter of 2019. This is of course the result of provisions for credit losses ballooning to $4.8 billion, up from about a billion in both the first quarter and final quarter of 2019.
Some modest buyback throughout 2019 and at the start of the year, made that the fall in earnings per share was a bit more subdued, with quarterly earnings totaling $0.40 per share, for a rate of $1.60 per share, down sharply from the $2.93 per share reported last year.
After peaking at $35 at the start of this year, shares were cut in half as they traded at $18 halfway March, before seeing a rebound to $22 at the moment. Based on these levels, shares trade around 7 times last year’s earnings and about 13-14 times current annualized earnings.
The interesting question is of course if the provision for credit losses, which annualized runs at $19 billion, is enough. Note that these provisions run at just about half the rate reported by JPMorgan (I am making a comparison here, as I have just covered its earnings report).
Bank of America has a slightly smaller balance sheet at $2.6 trillion, roughly half a trillion less than JPMorgan, yet the actual loans of $990 billion and $465 billion in debts securities look quite similar at a first glance. Of nearly $1.5 trillion in assets on which the bank has credit risk, an annualized provision of $19 billion looks a bit soft at around 1.3% of principal, given the current conditions and uncertainty.
On the bright side, Bank of America is a more residential bank compared to JPMorgan Chase which has more exposure to potentially riskier categories such as business loans, cards, but time will tell as delinquency and late payments do not result in defaults yet with the crisis only really unfolding in recent weeks, or the most recent month.
As I told you, the move from $35 to $18 and now $22 has some implications for the way the market thinks about the business and quality of the balance sheet in combination with the earnings power of the bank. Shareholder equity of $265 billion is virtually the same as JPMorgan, albeit with a slightly smaller balance sheet. The book value per share amounts to nearly $28 reflecting healthy skepticism, with shares trading quite a bit below that number. Based on tangible book value just a few pennies below $20, shares trade at a modest premium.
The market might be fearful that the current $19 billion annualized addition to loan-loss reserves is not sufficient to deal with the real earnings, although the modest addition to these reserves allows the company to still report a $3.5 billion profit in the first quarter, more than twice the dividend payment of the bank.
A Neutral Stance
Shares of the bank have lost about a third from their highs around $35 seen earlier this year, which given the recent market rally makes that shares have been underperforming the wider market. This might be explained by continued pressure on interest rate spreads, and the fact that banks will feel a great part of the pain, despite mitigating factors such as the direct and indirect bail-out or assistance provided by Uncle Sam.
Just like other peers and after seeing a huge multi-year momentum run, valuations did not look excessive at $35, with the bank trading at a low double digit earnings multiple, and depending on which book value metric you look, traded at a manageable premium to book.
While the bank enjoyed the benefits of a resilient economy, it was far from firing on all cylinders as the continued pressure on interest rates creates a continuous and significant headwind to the interest margins of the bank. With banks trading at a significant discount to the market in terms of the earnings multiples, it seems safe to say that investors had not gotten carried away and probably not too overconfident.
Based on last year’s earnings, the multiple has fallen to 7 times earnings which is a useless metric, as the current annualized earnings rate results in a 14 times multiple, as first quarter earnings are not telling enough as I fear that loan loss allowance additions are not sufficient to deal with reality. After all, these additions run at less than $20 billion a year now, equivalent to just over a percent of the loans they cover, and with banks modeling double digit declines in GDP and double digit percentages in unemployment, that just seems quite optimistic, despite all the programs initiated by the government.
Truth be told, Bank of America has done a lot of things right coming out of the crisis as it has become more prudent with the leverage ratios of the bank and also the funding strategy, having replaced a lot of (short term) debt with more stable deposit base. Nonetheless, the deposit base might come down in a crisis as well, although the size of the balance sheet might stabilize or fall a bit as well, depending on the circumstances.
Promising is that ahead of the loan loss provisions, the pre-tax profit numbers were down just a little from last year which is encouraging given the move lower in interest rates, although the room to cut interest rates on deposits/savings accounts is falling, rapidly approaching the zero bound.
Right now the market is not just balancing the impact of the virus on the economy and loan losses, but also which part of the damage will be “taken” by the government, with many programs in development, still surrounding quite some uncertainty.
Depending on the measures you look at, the premium to book has disappeared to a large extent, as the market still largely believes the quality of the loan book of the company, yet a discount might arise quickly if conditions are perhaps tougher and result in more defaults than the current consensus. This comes as Bank of America is quite conservative in making loan-loss reserves, that is adding modest provisions, which is of course an aggressive practice.
Having a firm belief that bank investors and bank management might be a bit optimistic on either the economic conditions, or degree to which the banks (indirectly) and their clients (directly) will see assistance/bailout, I am still cautious on the market at large here, in particular bank stocks. While current times might create an excellent buying opportunity, and banks are relatively well-capitalized with sufficient liquidity, I am fearful about much larger losses than anticipated by many here.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.