Many investors vividly remember some of the darkest days of the Great Recession. Additionally, the collapse of Silicon Valley Bank a few years ago sent ripples through the industry.
That said, investors tend to hit the sell button on bank stocks when economic stress starts to emerge because of their vulnerability to a brosder slowdown. That's already begun to happen this year, but it's clear that Bank of America(NYSE: BAC) and its other large bank peers are in a much better position than they were heading into the Great Recession. Here's why.
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Transforming into a more conservative bank
While JPMorgan Chase's Chief Executive Officer Jamie Dimon grabs a lot of the headlines in bank land, Bank of America CEO Brian Moynihan was also around during the Great Recession and saw what it did to the industry. Moynihan became CEO in 2010, and many have lauded him for his conservative growth strategy.
Some argue that strategy has been too conservative. Since the fourth quarter of 2009, Bank of America has hardly increased its total loan balances, although stricter regulation has led to less lending across the sector.
In Bank of America's most recent earnings presentation, management included a slide that showed just how much Bank of America has improved since 2009 in terms of safety and soundness:
Image source: Bank of America.
The first thing to notice is how much the composition of the loan portfolio has changed. Mortgages were a big issue during the Great Recession, but today, the bank has significantly reduced its exposure to consumer loans and home equity loans .
Additionally, banks are underwriting much better loans than before the Great Recession and generally require much more equity from borrowers. Wealth management loans have more than doubled, while commercial real estate construction loans only make up 15% of total loans, compared to 39% back in 2009.
Nonperforming loans and net charge-offs (essentially loan losses) are nowhere near the levels they hit during the peak of the Great Recession. Some may argue that the economy hasn't yet been triggered in the same way as during the Great Recession, and that triggering event could be right around the quarter. However, the last three line items in the slide make all the difference.
Tangible common equity is nearly double what it was in 2009, while global liquidity sources are up more than fourfold. Bank of America also points out that in the Federal Reserve's annual stress-testing exercise, the bank is expected to see losses equivalent to 5.5% of total loans, whereas loan losses were as high as 10% in the fourth quarter of 2009.
Stress testing is theoretical. However, the Fed puts banks through some pretty rigorous hypothetical simulations in which the agency stresses bank balance sheets to see how they would fare if unemployment rises to, say, 10%, gross domestic product falls drastically, and commercial real estate, housing, and other asset prices fall significantly, as well.
The bank is prepared
Banks will always carry risk due to the very nature of their business because they use leverage to generate profits. It all comes down to how banks manage that risk. Given the way Bank of America has expanded its loan book and reshaped the portfolio, I find it very unlikely that it will run into a credit problem it couldn't deal with.
On the company's earnings call, Moynihan said the bank regularly conducts stress tests of its own to see how it would hold up in a recession. "And so that's where the underwriting discipline of the last decade holds you in good stead if, in fact, we do enter a recession in the future," he said.
New challenges can always emerge, especially if the economy falls into some kind of scenario involving stagflation, but large bank stocks are way better prepared for an economic disaster than they were 15 years ago. Trading at 138% of its tangible book value (TBV), Bank of America's stock trades below its five year average of 156%.
This presents a favorable risk-reward proposition, especially if some of this trade uncertainty presented by President Donald Trump's tariffs gets sorted out.
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Bank of America is an advertising partner of Motley Fool Money. JPMorgan Chase is an advertising partner of Motley Fool Money. Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America and JPMorgan Chase. The Motley Fool has a disclosure policy.
