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  1. Home
  2. / Investing
  3. / Stocks

Banks Could Get Whopped by a Recession. But Bank of America Is a Fighter

Let's see why BAC might be a buy amid fears of an interest-rate induced recession.
By BRAD GINESIN
Sep 23, 2022 | 12:14 PM EDT
Stocks quotes in this article: BAC, JPM, GS, MS

As Federal Reserve Chairman Jerome Powell seems almost intent on causing economic pain with a series of aggressive rate hikes to quell inflation, investors are wary that a recession would cause trouble for the banks. That's historically been the case -- as joblessness spikes, problem loans emerge, and fewer people seek to borrow cash.

But would that be the scenario this time? The market has already been discounting an adverse economic scenario for banks, ignoring the offsetting benefits of higher interest rates on net interest income. Yet, one bank in particular, Bank of America (BAC) , is the top bank to buy into market weakness, with shares too cheap to ignore.

Bank of America's CFO spoke at a conference on Tuesday, giving confidence in the strength of the franchise and its customers. The message is that the U.S. consumer is in solid shape and its core portfolio is performing well for both the consumer and commercial.

Large banks have been buyback kings for a decade. Since 2013, Bank of America has bought back 22% of its outstanding shares, reducing share count from 10.72 billion to 8.03 billion. Buybacks have been on pause for BAC and JP Morgan (JPM)  as regulatory capital requirements increased this year. After the pause to build capital -- the Fed raised the capital requirement by 90 basis points for Bank of America -- these banks will prioritize and resume aggressive buybacks in coming quarters. As an aside, BAC has appealed the requirement, questioning the Fed's methodology.

Banks will be beneficiaries of rate increases, leading to increased net interest income. This year, with recession fears, waning deal-making income, and temporarily halted stock buybacks, shares of the largest banks have floundered. Stocks in the banking sector are caught between the positives of higher rates and the fears of recession and loan losses.

Long-time bank analyst from Wells Fargo, Mike Mayo, is bullish on BAC with an aggressive $55 target. He believes that recency bias leaves investors mistakenly believing that a potential recession would be a severe credit event for banks. Also, he believes investors are under-appreciating the degree to which the industry's net interest margins will return closer to normal after being suppressed for the past 14 years under close to zero rates. In a post-Fed research report, he noted, "After Wednesday's Fed 75bp rate hike, our confidence increases that NII should show the fastest growth in 4+ decades. The mitigating risk is the increased chance of a recession, though estimated NII growth is enough to offset estimated 4x higher credit losses."

BAC is at the same level it traded in 2018, yet earnings are up over 20% and the outstanding shares are down around 20%. Interest rates are currently significantly higher, portending materially higher profits in 2023. Wall Street expects earnings to increase from $3.19 in 2022 to $3.81 in 2023. Clearly, investors are more concerned about discounting the negative potential of a recession than the earnings growth generated by higher rates.

Berkshire Hathaway owns 12.85% of BAC, its second largest position. Indeed a vote of confidence in the stock's value proposition, especially after pulling back 35% off its February high.

Granted, Wall Street firms are struggling with slow investment banking fees and deal-making drought. While Bank of America is feeling some pain, JP Morgan, Goldman Sachs (GS) , and Morgan Stanley (MS)  are far more weighted to underwriting and investment banking fees.

When investing, there's a time to sow and a time to reap. For Bank of America, it's worth sowing seeds by investing in one of the top banks while the sector is out of favor and the stock is cheap -- approaching its approximately $30 book value. There will be a time to reap gains in BAC when the economy emerges from under a cloud of interest rate and inflation uncertainty.

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At the time of publication, Ginesin was long BAC, JPM, and GS.

TAGS: Stocks | Banking | Investing

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