With the banking sector in crisis and Warren Buffett being very well versed in the industry, there’s been a lot of speculation circulating about how Buffett’s company Berkshire Hathaway (BRK.A) (BRK.B) might invest in regional bank stocks.

It’s certainly possible, but if investors are looking for ideas right now, they need to look no further than Berkshire’s existing portfolio. While Berkshire owns many stocks in many industries, the one I’m most excited about is Bank of America (BAC), which is the second-largest position in Berkshire’s portfolio, although it has sold off intensely along with the rest of the banking sector.

This presents a good opportunity to get in on America’s largest bank, as the stock hits lows not seen since the middle of 2020 when the pandemic was raging.

The elephant in the portfolio
Now, there’s a good reason that Bank of America has sold off this month. After the collapse of SVB Financial, the market has been paying close attention to banks with an outsized amount of unrealized losses in their held-to-maturity (HTM) bond portfolios.

HTM bonds are those that banks intend to hold until they mature, and they are not accounted for in a bank’s equity calculation each quarter. So if Bank of America ever did see significant deposit outflows and had to sell these bonds while they traded at a loss, they would wipe out a significant amount of shareholder equity. At the end of 2022, Bank of America had close to $172 billion of tangible common equity and nearly $109 billion of unrealized losses sitting in its HTM folder.

That’s a lot of unrealized losses to be sure, but Bank of America is nothing like SVB. It operates all over the U.S. and world and has one of the largest commercial lending franchises worldwide. It also has more than $1 trillion of retail deposits and operates a large investment bank and a large wealth business.

Bank of America’s deposit base is much more diverse than SVB’s — arguably one of the most, if not the most, diverse in the industry. At the end of 2022, Bank of America had more than 112.7 million bank accounts each with less than the $250,000 limit insured by the Federal Deposit Insurance Corp. (FDIC).

No signs of liquidity issues — quite the contrary
As long as Bank of America holds bonds until maturity, it will not incur any unrealized losses. Additionally, with the 10-year U.S. Treasury yield now down close to 70 basis points (each basis point equals 1/100 of a percentage point) since early March, some of Bank of America’s unrealized losses among its U.S. Treasury bills should decline, allowing it to potentially reposition the balance sheet.

There’s also been no sign that Bank of America is having any issues with liquidity. In mid-March, right after the collapse of SVB and Signature Bank, media outlets reported that Bank of America had quickly vacuumed up $15 billion of deposits. Additionally, on March 22, Bank of America said it had redeemed $1 billion of fixed- and floating-rate senior notes, more than a year ahead of schedule. Bank of America also injected $5 billion of deposits into First Republic, all actions that suggest it is not dealing with liquidity issues.

It’s hard to say at this moment how all of this plays out because there are a lot of variables when thinking about how deposits are trending right now. Yes, Bank of America is likely seeing more deposit inflows, but it also has a lot of customers in cheaper checking accounts that could be rotating into higher-yielding bank account products.

I also don’t think Bank of America is going to be overly eager to deploy new deposits right now into anything with extended maturities, given the volatility, although there is a case of perhaps putting funds into short-term securities. But I don’t believe Bank of America is experiencing any liquidity issues that would lead it to have to sell any of its bonds. On the contrary, deposits may have increased in the first quarter more than the bank had expected before SVB failed.

A great entry point
There’s still plenty of uncertainty out there, and I can’t tell you whether the turmoil has run its course. The economy may also now be headed for a recession. While there may be some earnings challenges ahead, I expect Bank of America to still be a good long-term performer.

Bank of America now trades at just 123% of its tangible book value, or net worth, which is toward the very bottom of where it has traded since 2017.

There’s a reason Berkshire has increased its position in Bank of America even as it has sold other bank stocks over the last three years; it’s because the bank can weather and successfully navigate a difficult environment. I expect this time to be no different.

— Bram Berkowitz

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Source: The Motley Fool