Consolidation In The Banking Sector Will Increase Revenues

Key Takeaways

• BAC offers diverse services globally including banking, investments, risk management, and more to public and private clients.
• As a Big 4 US bank, it remains strong despite sector turmoil, poised for consolidation, and maintains a solid brand.
• Despite economic risks, BofA has a resilient loan book and solid profit margins
• BofA needs diversification globally and cultural change to address controversies and issues.

Catalysts

Company Catalysts

Reputation and brand strength will keep deposits high

BofA has a strong track record and is one of the world's largest and most recognizable financial brands. Even in crises, the bank was resilient and often a contingency solution provider – like in 2008 when it bought distressed Merril Lynch. Despite recent turbulence in the banking sector, the bank's strength kept deposit outflows to a minimum, losing only US$20 billion in Q1. Based on this evidence, I believe that the bank will benefit from further consolidation in the sector.

Service and digital engagement growth to help capture more of the market

BofA is a true one-stop shop for financial markets providing every conceivable product or service to every kind of client. It is a leading US bank in several categories like online & mobile banking, small and medium enterprise lending, and the bank with the most U.S. retail deposits.

If Bank of America is successful in continuing to grow its digital banking platform, it should be able to capture a larger market share and reach more customers. This could help to increase its deposit base and lending activities, leading to higher revenues and earnings. Additionally, a strong digital presence could help the company to reduce costs and improve efficiency, further enhancing its financial performance. BofA’s consumer banking segment grew its digital sales by 4% year over year, and digital sales represented 51% of total sales, while active mobile banking users continued steady growth from 35.5 million in Q4 2022 to 36.3 million users in Q1 2023.

Strong balance sheet and lower risk debts on the books make BofA a safer bet

BofA passes all of Simply Wall St's Financial Health Checks. It has a healthy assets-to-equity ratio, and most of its liabilities come from low-risk funding sources. The bank has a healthy loan book with non-performing at just 0.47% - the lowest out of the Big 4 banks.

If Bank of America is able to effectively manage its capital and return excess capital to shareholders through dividends and buybacks, then this should be viewed positively by investors. It may also attract new investors who are seeking stable and consistent returns. In turn, this could help to support the company's stock price and market valuation.

Industry Catalysts

Erosion of trust in banks and financial institutions

The recent past has seen troublesome events in the banking sector as rapidly rising interest rates pressure banks like the Silicon Valley Bank– causing their balance sheets to deteriorate and fuel bank runs.  Although BofA is a far better-managed institution, it still suffers from negative sentiment due to this bias just like other big banks, which are becoming “even bigger to fail.” BofA has outperformed its peers but still underperformed the broad market in 2023 so far. I believe the negative sentiment around banks at the moment has been overdone on the likes of BofA, and this stock will likely re-rate higher when the dust has settled.

Interest rate impact

If the US economy continues to recover and interest rates rise above the current 5-5.25% rate, then Bank of America should expect to see a significant increase in net interest income. Although interest rates have been low recently, their historic average since the 1970s is close to 5.5%.

This rise would result in greater revenues and earnings for big banks, and may also help to offset any potential declines in non-interest income. Additionally, if banks like BofA are able to maintain a strong loan portfolio and keep credit losses low, this should further support their financial performance.

Recession impact

Recessions are usually negative for the banking sector as lower interest rates surpass bank earnings and force them to focus on unpopular non-interest income like fees, service charges, etc. If the market turmoil forces the FED to pivot and start cutting rates, this development could negatively impact the banking sector.

Assumptions

• I’m assuming large banks will continue to outperform small banks, attracting more deposits and solidifying their position as dominant banks.
• I believe interest rates in the US will remain elevated, providing a tailwind for conservative banks like BAC.
• BAC will expand its presence in regional untapped markets like Ohio, Minnesota, and Colorado after successfully opening first centers there in 2019.
• Revenues from the domestic market to remain over 80%, with forward revenue growth hovering around 4%.
• Dividend growth will remain at 10% per year, bringing the dividend yield closer to 4%

Risks

There are some risks to my narrative worth noting that could alter my expectations.

Lawsuits and controversies

Large corporations often end up in court, and BofA has had its share of controversies over the years. These include a recent US$75 million settlement over overdraft fees it didn't earn, with total fines for FY2022 reaching a staggering US$1.2 billion.

Lawsuits identified weaknesses such as poor handling of jobless benefits during the pandemic or using unauthorized messaging platforms such as WhatsApp. The use of 3rd party applications for handling sensitive data is perilous, as proven in April 2020 when a security breach exposed information from the bank's Paycheck Protection program. While it is unrealistic for such a large corporation to be flawless, the persistence of such issues over the decades indicates a growing problem that the management has to deal with.

High concentration in the domestic market

BofA has global operations, but over 80% of its revenue comes from US operations. This fact might indicate a diversification weakness as the bank might be missing out on emerging market opportunities and a higher risk of concentrated exposure in the domestic market.

Lack of competitiveness in some categories

BofA has many advantages, but it lacks in offering popular financial products like certificates of deposit (CDs) – a savings product that earns interest on a lump sum for a fixed period of time. BofA offers a much lower yield than some of its key competitors. The situation with other interest-bearing products doesn't seem to be much better either and low yields during high interest rates could potentially see money outflows to competitors who offer more.