Bank of America: Buy, Sell, or Hold?

In the third quarter alone, Warren Buffett and his team at Berkshire Hathaway have offloaded a staggering 235 million shares of Bank of America (NYSE: BAC). The conglomerate's share sales were notable, as Berkshire's previous stake was more than 10%, which required public disclosure via Form 4 to the Securities and Exchange Commission (SEC) every time it made a sale.

Rising interest rates in recent years have taken a toll on Bank of America's bond portfolio, and it currently sits on $89.4 billion in unrealized losses. However, with interest rates expected to fall over the next year, Bank of America stands to benefit. If you're thinking of investing in the bank or currently hold the stock, consider the following.

Reason to sell Bank of America

Investing in banks can be complex, especially with fluctuating interest rates. That's because banks borrow money short term, primarily through customer deposits, and lend out that money long term. As a result, a bank's profitability hinges on the difference between the interest earned on loans and the interest paid on deposits, making banks' cyclical stocks sensitive to interest rate changes.

Recent spikes in interest rates have been a mixed bag for Bank of America. On the one hand, net interest income surged to $56.9 billion, growing 33% during the two years ended in 2023. However, the bank has also experienced a dramatic increase in unrealized losses within its loan portfolio, ballooning from $14 billion in 2021 to $102 billion last year.

Unrealized losses don't have to be realized losses as long as the bank can hold the assets in question to maturity. However, these losses could be realized when a bank has to sell its securities to raise capital or cover deposit withdrawals. This risk was highlighted by the situation faced by Silicon Valley Bank (a subsidiary of SVB Financial). The bank suffered a run on its deposits in March 2023, forcing it to liquidate underwater assets to raise capital. This led to deep losses, forcing federal regulators to seize the bank.

While these unrealized losses can appear alarming, they don't necessarily spell doom for Bank of America, which boasts a stable, robust $1.9 trillion deposit base across various client groups, geographies, and industries.

However, the opportunity cost of having capital tied up in lower-yielding investments hinders its profit potential. Compare this to other banks, like JPMorgan Chase, which stockpiled cash in 2021 for potentially higher rates and have been one of the biggest beneficiaries and best performers during this interest rate cycle.

BAC Total Return Level data by YCharts

Investors who have soured on the way Bank of America has handled its loan portfolio may find today a good time to take some profits.

Reason to buy or hold Bank of America

Last year, the Federal Reserve paused its interest rate hiking cycle and it recently began lowering its benchmark interest rate. This caused Bank of America's net interest income to fall about 3% through the first three quarters of this year. However, falling interest rates have also helped it reduce its unrealized losses to $89.4 billion at the end of the third quarter.

One positive is that the securities in its held-to-maturity (HTM) portfolio continue to mature and run off. According to Chief Financial Officer Alastair Borthwick, about $9 billion was freed from its HTM portfolio in the third quarter, allowing the bank to reinvest this capital at higher interest rates (compared to pre-2022 levels). This, coupled with a steepening yield curve, puts the bank in a position to increase net interest income next year.

Not only that, but the recent election results could bode well for banks. That's because investors are optimistic about a pickup in investment banking activity along with less stringent Basel III endgame reforms, which may provide banks with more capital than initially expected.

BAC PE Ratio data by YCharts

Bank of America is trading at the slightly higher end of its average valuation, at 16.7 times earnings and 1.74 times tangible book value, but I don't think investors should be too concerned about Buffett's share sales. Buffett could be selling for various reasons, including bringing Berkshire below its 10% ownership threshold or freeing up capital to get ready to hand over the reins of the investment portfolio to his team at Berkshire.

While its performance naturally ebbs and flows with the U.S. economy and prevailing market conditions, Bank of America has shown resilience. The stock is on the pricier side of its valuation, so the upside may be more limited, but it remains a solid bank stock to continue holding long-term.