Bank Of America: Fed Stress Tests Were A Disaster For Shareholders

Summary

• Banks with large consumer exposure were ambushed by the recent stress tests, none more so than Bank of America.
• BAC, which seemed about to benefit greatly from increased NII due to rising rates, instead found itself constrained to radically reduce buybacks and look over its shoulder at the Fed.
• One can argue whether the Fed was “capricious,” as Jamie Dimon did, but the banks must also ask why they didn’t see it coming and prepare.
• BAC’s shareholders will suffer the most because buybacks were important to the premise for owning it; top leadership avoided questions at the recent earnings call.
• Operating results were fine looking backward, but BAC leaders should explain how they dropped the ball on the stress tests and what they plan to do about it in the future.

Bank of America (NYSE:BAC) is about to suffer from a major lost opportunity thanks to the recent Federal Reserve stress tests. It shouldn’t have come as a surprise. The handwriting should have been on the wall for anybody who noticed the CET1 (Common Equity Tier Number) in its Q4 2021 end-of-the-year report. The fifth line of the first slide reported a standardized CET1 ratio of 10.6. It struck me at the time that this was pretty close to the 10.5 the Fed was going to require on the stress tests. I checked other banks and BAC compared unfavorably with its peers.

Everybody loved BAC and saw that it was going to book big time with rising interest rates. Bank of America was well aware of this advantage and its earnings call slides included a line saying how much their income would benefit per 100 basis point lateral increase in interest rates. Under CEO Brian Moynihan, Bank of America had turned itself around after the 2008-2009 disaster and gone from strength to strength. It had taken care of both customers and employees during the pandemic and lockdown and still made good money. Now that they were getting that rise in interest rates they should race ahead of all other diversified banks.

The only thing to worry about with BAC was that it had the most exposure to consumer banking among its peers and as a consequence held more of the kind of loans that would be heavily discounted by the Fed in the upcoming stress test. I wrote about the difference between investment banks and diversified banks with large consumer exposure in this article on Goldman Sachs (GS). The short version is that investment banks are structured so as to do better on stress tests……More Here

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