Berkshire Hathaway(NYSE: BRK.A)(NYSE: BRK.B) sold off nearly 52.8 million shares in Bank of America(NYSE: BAC), its second-largest holding, over the course of six days in late July. The stake amounted to around $2.3 billion, and it is the first time Berkshire has trimmed its position in the second-largest U.S. bank since 2019.
Bank of America (BofA) stock has performed well since Berkshire first invested in it in 2011, returning around 12% compounded annually. At the end of the second quarter, BofA made up around 11% of Berkshire's total portfolio. Should investors be concerned about its repeat selling?
BofA is sitting on huge unrealized losses
In brief, banks borrow money in the short term (in the form of customer deposits) and lend it over the long term. They earn money on the difference between the interest they get from loans or other investments and the interest they pay on deposits. As a result, banks are cyclical stocks sensitive to fluctuations in interest rates.
The recent period of rising interest rates has been a double-edged sword for banks. Early on during the Federal Reserve's rate-hiking cycle, the bank's net interest income was expanding at a rapid rate. In 2022, Bank of America's net interest income grew 22%, and it grew another 9% last year.
On the other hand, Bank of America's loan portfolio has suffered. The bank's unrealized losses have grown from $14 billion in 2021 to $115 billion. These unrealized losses represent the bank's losses if it had to sell its securities in the market today. Silicon Valley Bank, the subsidiary of SVB Financial, is one example of a bank that had to realize losses on its portfolio due to a run on its bank deposits in March 2023.
Chart by author.
The unrealized losses are unpleasant but shouldn't be a problem for banks that can hold those loans to maturity. A run on Bank of America is unlikely, given its deposit base of 37 million consumer checking accounts and $1.9 trillion in deposits diversified across industries, geographies, and customer classes.
Unfortunately, there is an opportunity cost with the bank's capital tied up in lower-yielding, longer-maturity investments that will take time to come off the books. Contrast that with JPMorgan Chase, which hoarded cash in 2021 to prepare for the possibility of higher interest rates, which eventually proved true.
Another factor is deposit rates, which have adjusted higher industrywide, from 0.06% in early 2022 to 0.45% in June 2024. Coupled with slower loan growth, Bank of America's net interest income fell 3% in the first six months of this year.
Today, Bank of America shares trade at a price-to-earnings (P/E) ratio of 14.7, which is right around its 10-year average P/E ratio. Its price-to-tangible book value (P/TBV) is around 1.64, a bit above its 10-year average but nothing out of the ordinary.
BAC PE Ratio data by YCharts
Is Bank of America a sell?
We don't know for sure why Buffett and his team at Berkshire continue to sell their stake in Bank of America. Perhaps the bank's balance sheet management over the past several years is one reason. Or maybe it cut its position in anticipation of higher taxes. Another possibility is that Buffett wants to give his successors ample capital and flexibility.
Investors shouldn't fret. Bank of America is a large, diverse bank and can benefit if interest rates stay higher for longer than in the 2010s. That's because it has a lot of fixed-rate assets maturing, and it can reinvest this capital into higher-yielding assets.
On top of that, projected interest rate cuts from the Federal Reserve could lower short-term interest rates, bringing down the cost of deposits, and it anticipates net interest income reversing course and growing again in the second half of this year into next.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. SVB Financial provides credit and banking services to The Motley Fool. Courtney Carlsen has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America, Berkshire Hathaway, and JPMorgan Chase. The Motley Fool has a disclosure policy.
