The bank sector, including Bank of America (BAC), has failed to keep up with the stock rally due to fears over loan losses. The sector is trading at book values comparable to the lows of the prior decade despite easily surviving the recent Fed stress test. Upcoming Q2 results will focus on investors are large credit losses, but the investment thesis remains highly bullish on BoA with the 3% dividend yield and limited risk to the long-term business model.
While the banks caused the 2008 financial crisis, the large financials have very limited risk of material damage to this crisis. Even under the severely adverse economic situation of the Fed with 10% unemployment, the Dow dipping 50%, and real estate prices collapsing, BoA ends the crisis with a strong capital position.
The bank started the stress test period with CET1 at 11.2%. BoA is predicted to end the period with this capital ratio at 9.0% and a low during the cycle of 8.5%.
Similar to the whole banking sector, BoA expects to absorb billions in losses during the 9 quarter stress period. The numbers are likely far worse than the actual COVID-19 shutdown facing the bank sector now.
The large banks report Q2 earnings this week with BoA reporting before the market opens on Thursday. In the hypothetical stress test, the large bank is forecasted to take a $46.5 billion provision for loans and lease losses and another $10.5 billion in trading losses along with a $10.0 billion goodwill impairment. In total, the losses are estimated at $24.1 billion above the $47.0 billion in pre-provision net revenue during the period.
BoA already took a $4.6 billion loan loss provisions in Q1 and the bank is likely to report a larger Q2 loan loss. The current downturn isn’t expected to last much beyond Q3 so the bank will see far better lower credit losses forecasted in the 2020 stress test.
Since conducting the stress tests, the Fed has changed how large banks can pay dividends. The bank is limited to only paying out actual earnings for the trailing four-quarter period with dividends capped at Q2 levels. BoA doesn’t appear at risk with analysts forecasting the bank generating a 2020 EPS far above $1.00 per share and the current dividend payout is only $0.72.
The bank only has a 3.0% dividend yield due to the rather small capital returns targeted at dividends. The Fed also prevented share buybacks while the large banks had already suspended buybacks back in March when the COVID-19 crisis started.
While BoA has plenty of capital at double the regulatory capital minimum of 4.5%, the Global Systemically Important Bank Surcharge of 2.5% and the additional 2.5% stress capital buffer requires the bank to maintain a CET1 ratio of 9.5%. The bank ended March with a 10.8% ratio.
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