Bank of America has leading franchises across multiple parts of the US financial services industry and is moving past numerous legal and regulatory issues that have plagued it in recent years. UBS expects Bank of America Corp (NYSE:BAC) to post low to mid teen earnings growth in the coming years due to its high earnings sensitivity to increasing interest rates and efficiency improvement efforts. However, the shares have meaningfully outperformed since interest rates troughed in mid- 2016, and, to UBS, price in optimism about earnings upside being achieved versus base case estimates. Bank of America trades at 13.6x 17E earnings, premiums to both JPMorgan (13.1x 17E) and Citigroup (11.4x 17E).
After declining meaningfully from 2010 to 2015, NII growth is on the upswing. Bank of America benefits disproportionately from higher interest rates when compared to most banks due to its attractive deposit franchise and relatively large exposure to mortgage backed securities. According to company regulatory filings, every 100 bps parallel shift in the yield curve adds $5.3 bn to NII, equivalent to 21.0% of 16E pre-tax earnings.
UBS adjusted existing earnings power to incorporate the full benefit of a 100 bps parallel shift in the yield curve, reaching a targeted expense base of $53 bn ($55 bn in 16E), and a five percentage point reduction in its tax rate. UBS arrives at a $2.09 EPS figure, or about 43% higher than 16E earnings. Notably, Bank of America trades at 10.8x this stylized EPS figure, only moderately below its long term PE average of 11.1x.
UBS is assuming coverage with a Neutral rating (previously Buy). UBS $23 per share price target (previously $24) is based on a two stage residual model, which estimates a company's excess returns (ROE minus cost of equity multiplied by average shareholders' equity) over a ten year forecast period, and equates to 11.9x 18E earnings/0.89x 17E BV.