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Morningstar | Good 2Q for Bank of America; Consumer Franchise Displays Strong Fundamentals as Rate Cuts Loom

Wide-moat Bank of America reported good results for the second quarter of 2019. Revenue increased 2%, driven by net interest income growth of 3% and fee income growth of 1.6%. This occurred on top of a stable expense base, leading to net income growth of 8%, and a 7% reduction in average shares outstanding helped drive EPS growth of 17%. The return on average tangible common equity was 16.2%, a solid result. Overall, Bank of America is hitting its targets, with roughly stable credit costs and expense base leading to operating leverage and earnings growth. Management believes they can slightly beat their original expense targets for 2019, which should insulate the bank from some of the pressure of any rate cuts. We are now incorporating three rate cuts into our forecasts through 2020, and after making these adjustments, we are lowering our fair value estimate to $32 per share from $33.

We think the true power of Bank of America’s franchise was on display during the quarter. The bank is able to invest massive amounts in technology while keeping its expense base flat as previous investments yield expense savings, feeding the next round of investment. The bank’s franchises are also well diversified, as strength in the bank’s consumer banking and wealth segments more than offset pressure in the global banking and markets segments. We have been impressed by the bank’s ability to grow primary customer relationships on the retail side, and even in the (for now) higher interest-rate environment, Bank of America is still managing to grow checking accounts faster than more costly deposit accounts, such as CDs. The bank is also making admirable strides in its wealth segment, as net new Merrill Lynch households were up 45% compared with the first half of last year, and the bank is still managing to achieve positive net asset flows. While interest-rate pressures will undoubtedly affect the bottom line, Bank of America’s fundamentals are strong, and we see no reason for this to change. Bank of America is one of the strongest franchises we cover, quite a feat for a bank that went through so much during the global financial crisis.

Market-related revenue growth will come and go and can be volatile. This quarter was no exception, with corporate investment banking fees down 4%, and in sales and trading, fixed-income, currencies, and commodities revenue was down 8%, and equities revenue was down 13%. Even so, Bank of America managed to gain some share in key categories, and the bank is executing on its goals of re-energizing its I-banking franchise.

Consumer banking had a strong quarter, with average deposits up 3%, average loans and leases up 5%, and the bank is gaining core customer accounts and investment assets. Management also highlighted that a disproportionate amount of customer growth is coming from millennials, signifying to us that banks are indeed still very much relevant and even successful in appealing to the next generation of consumers. Credit quality has remained fairly stable. Net charge-offs were down a bit during the quarter, but this was largely due to some one-time recoveries. Normalizing for this, they would have been right around $1 billion, which is what management expects to continue for the rest of the year. We did see a slight uptick in commercial net charge-offs, but management said they were due to only a handful of accounts and did not represent a trend.