At the end of the second quarter of 2020, Bank of America Corp (BAC, Financial) was the second-largest position in Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) extensive equity portfolio. Warren Buffett (Trades, Portfolio)'s conglomerate owned 925 million shares in the banking group. The position accounted for 11.2% of the portfolio, making it the second-largest holding after Apple's (AAPL, Financial) 36%.
Buffett has also increased the Bank of America position by $2.1 billion, or 10%, since the end of the second quarter.
So what does Buffett like about Bank of America in particular? The banking sector as a whole is facing some severe headwinds right now. The coronavirus pandemic has led to America's biggest banks suffering steep declines in net interest margin, traditional banking revenues and total revenues.
These financial institutions have also had to write off tens of billions of dollars in bad debt already. For example, Bank of America's second-half results fell around 50% year-over-year. The group reported $5 billion in loan loss charges linked to the pandemic. It's unlikely the situation is going to improve any time soon. More loan losses seem likely before the end of the year given the economic recession.
That said, we know Buffett never buys an investment based on its prospects for the next 12, 24 or even 36 months. He buys stocks when he plans to hold them forever. It is unlikely to be any different with Bank of America.
Buffett has previously called banks good businesses because they can earn very high returns on tangible capital. These are just a sort of companies Buffett has sought out throughout his entire career. Bank of America's return on tangible equity has ranged between 8% and 14% during the past five years.
Buffett may be attracted to the lender for its other desirable qualities as well. The bank is extremely well capitalized and has strong recognition among consumers across the country.
Bank of America's required CET1 ratio is 9.5%, but its current CET1 ratio at the end of the second quarter is 11.6%. These numbers suggest that unless there's a significant deterioration in loan losses, the bank can potentially return a substantial amount of capital to investors in the years ahead. The bank already has an impressive track record on this front. At the beginning of the year, Bank of America was targeting $37 billion of capital returns in 2020. That was equivalent to a shareholder yield of 12.2% at the time. In 2019, the ratio was around 14%.
Conclusion
All of the above indicates that Bank of America is a highly profitable company and is committed to returning capital to shareholders. Few other businesses offer the same kind of profitability and return profile.
Right now, investors can buy a share of this business for less than book value and less than 10 times earnings. From a value perspective, the stock is cheap, and from a quality perspective, it is also a desirable investment, in my opinion. These qualities make it clear why the Oracle of Omaha is interested in buying the business.
Disclosure: The author owns shares in Berkshire Hathaway.
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