Pending interest rate hike
Bank of America (BAC), like most other banks (XLF), stands to benefit from an interest rate hike. According to company data, the company would earn an additional $6 billion in net interest income if short-term and long-term interest rates rose by 1%.
Notably, net interest income makes up ~50% of BAC’s revenues, and so rising interest rates represent a strong growth driver for the company’s share price.
Growth in trading revenues
The first quarter of 2016 was not favorable to client activity and trading, as financial markets were extremely volatile. Volatile markets have kept clients away from issuing debt or equity, launching IPOs (initial public offerings), or making acquisitions.
BAC’s earnings took a hit in 1Q16 due to lower trading revenues. But market activity has improved during the past two months, and most banks expect trading activity to pick up.
Positive outlook for oil?
Bank of America’s exposure to the energy sector was $21.8 billion in 1Q16, which makes up 2.4% of its total loans. By comparison, the bank has 4.6% in energy reserves.
For this reason, falling oil prices hurt the company’s earnings in 1Q16 as banks created provisions against losses on loans to the energy sector. But during the past two months, oil prices have rebounded, topping $50 a barrel, and analysts forecast oil prices to rise even more.
Wealth management expansion
According to a Reuters report, Bank of America plans to expand its Wealth Management business in order to strengthen its top line. Low interest rates and uncertain macroeconomic conditions have hurt the bank’s revenue-generating capability from investment banking and trading activities. Banks are now focusing on wealth management to boost their earnings.
Currently, shares of Bank of America trade at a discount of ~38% to its book value. Most of its peers—JPMorgan Chase (JPM), Wells Fargo (WFC), and Goldman Sachs (GS)—are trading between 1x–2x their book values.
But to be sure, the main reason why BAC’s trading at a low share price is because the company’s profitability has been so poor. Now that its profits are rapidly improving, low valuations mean the stock has strong upside potential.
In the next part, we’ll keep discussing key growth drivers in detail.