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Despite COVID-19 closures, Bank of America (NYSE: BAC) actually hit new highs while still trading at a cheap multiple. The big bank should reap massive benefits from higher interest rates after taking a big hit to net interest income in 2020. My investment thesis remains bullish on the BoA continuing to push higher while rewarding shareholders with significant capital returns.

Price increase

Some economists are predicting that the Fed will raise interest rates by 7x in 2022, but on average the Fed is expected to raise rates by 3x to 4x this year. According to a CNBC survey, the Fed will raise interest rates up to 7x by the end of 2023.

Interest rate forecasts

Source: CNBC Fed Survey

BoA is one of the banks still positioned to benefit from higher interest rates. In theory, the big bank should benefit from the next cycle of Fed tightening, if monetary policy does not push the United States into a recession.

In the fourth quarter of 2021, the BoA generated $11.4 billion from NII, up 11% from $10.2 billion a year ago. The bank had an NII of $12.3 billion in the fourth quarter of 2019 before the COVID-19 shutdowns killed economic demand and prompted the Fed to cut interest rates.

Bank of America net interest income

Source: BoA Q4’21 presentation

The big bank estimates its interest rate sensitivity to be an incredible $6.5 billion over the next year from a parallel shift of +100 basis points in the yield curve. The forecast is for the Fed to raise interest rates by almost the same amount due to soaring inflation.

In 2019, the BoA was on a trajectory of $46.0 billion in annualized NII, suggesting about a 15% rise in NII from just higher interest rates and possibly more with more rate hikes. rate. The bank had a net interest yield of 2.35% in Q4’19, compared to 1.67% in Q4’20. The BoA was able to generate $12.7 billion of NII in the fourth quarter of 2018, as net interest yield was up 2.52%.

Evolution of BOA's net interest income

Source: BoA Q4’21 presentation

Average loan balances have rebounded in 2021, but loan balances are still down from 2019 levels and barely above 2018 levels. The BoA should be able to match higher loan balances with higher interest rates to propel the NII to new highs over the next year.

Increase in return on capital

For a bank with a market capitalization of $350 billion, BoA still returns massive amounts of the current share price to shareholders. For 2021, the largest financial institution has returned the following capital to shareholders:

  • Repurchase of $25.1 billion of common stock, including repurchases to offset shares awarded under stock-based compensation plans.
  • Paid $6.6 billion in ordinary dividends.

BoA now has a net distribution yield of 8.7% due to a dividend yield of 1.9% and the $25.1 billion redemption yielding a net redemption yield of 6.8%.

BAC stock price and payout yield
Data by YCharts

The BoA has returned almost all of its $32.0 billion in revenue it generated in 2021. Analysts expect earnings to decline in 2022, but the big bank is expected to have tailwinds in the 2H of the year as the Fed seeks to raise interest rates.

If the bank continues to reduce the number of shares by up to 7% per year, the BoA will benefit from a huge tailwind for years. The big financial saw the number of shares outstanding fall from 8.65 billion at the end of 2020 to 8.08 billion at the end of 2021. The BoA cut the number of shares by 570 million shares l ‘last year.

Big bank stock certainly doesn’t have the deep value of previous years when the BoA regularly traded closer to book value. Analysts estimate the shares are trading at just 14 times 2022 EPS estimates, but those EPS targets are expected to fall 9% from 2021 levels before returning in 2023.

Apart from higher costs, BoA looks set to continue to increase EPS. The stock has the main tailwinds of a much higher NII and lower share count, as well as what should be higher economic activity, including loan demand and higher credit card spending. standardized.

Carry

The key investor takeaway is that the BoA is no longer the big deal of a few years ago, when the stock traded barely above tangible book value. The stock is still trading low at just 14x 2022 EPS targets with several catalysts to increase EPS this year and significantly reduce the P/E multiple closer to the 2023 multiple of 12x.

With the heavy share buybacks and cheap valuation, BoA is a great stock to buy on weakness knowing that the company will be buying tons of shares alongside shareholders.