The financial meltdown of 2008 triggered a sense of awareness among investors regarding financial risks. As banks were essentially the epicenter of the crisis, investors find themselves reluctant about exposure to the banking industry. On the other hand, the fact remains that banks in the U.S. have posted a profit of more than 30% in the first quarter of 2013, and the banking industry is demonstrating remarkable confidence in its recovery from the crisis.
This is because it is felt that the amount of risk inherent in the banking system has been reduced and the regulatory pressure has also started to play its part. Despite the serious concerns about the industry's outlook, some of the larger banks are providing a decent opportunity to investors as the prices project a sizable potential for appreciation. Therefore, the risk-return profile is of interest to analysts as they aim to pick the players that will outperform the others.
Bank of America (BAC) is amongst the favorites in this scenario. The reason is mostly associated with the extraordinary degree of undervaluation of the bank. Indeed, the bank is substantially undervalued as it operates at approximately half its book value as opposed to the last decade in which it averaged around twice the book value up until the crisis. This is also true that the extent of cheap valuation of BAC is unmatched by other banks, which are posting equally impressive financial performance. However, this is not the only factor that makes BAC attractive to investors. There are other strategic factors at play most important of which is the bank's diversification strategy.
BAC operates under five major business segments, which include consumer & business banking, consumer real estate services [CRES], global banking, global markets and global wealth & investment management [GWIM]. Among these segments, consumer & business banking serves as the strongest source of revenues followed by global banking and GWIM. CRES is the only segment that has reported losses in previous years due to the grim situation of the housing market in U.S. and the foreclosure issues. These losses still persist as the bank reported a net loss of $1.3 billion in the first quarter of 2013. The robust structure of the bank's segmentation has proved critical as the losses were offset by the commendable performance of consumer & business banking, global banking and global markets. To be specific, the upside of acquiring Merrill Lynch was proved as the segment turned substantial profits for the bank.
Tracking Regional Exposure
Apart from the U.S., BAC operates in a number of other countries establishing a strong global presence. This non-U.S. exposure introduces new opportunities for growth and also limits the risks associated with the U.S. economy. The bank's exposure to the UK economy is about $46.5 billion, which accounts for approximately 23% of the bank's non-U.S. exposure. This is the largest exposure to a foreign economy followed by Canada, with a total exposure of about 9%. The exposure to some of the stronger emerging markets like Brazil and China has been increased as compared to the first quarter of 2013. The exposure to European countries has been limited due to the threats posed by the debt crisis. The most important variation witnessed in the structure of international operations, is with respect to Japan as BAC decreased its exposure by $17 billion.
Tackling Industry Specific Risks
The bank's commercial credit exposure also demonstrates a high degree of diversification indicating the emphasis on reducing risks. About 13.4% of its credit exposure is associated with diversified financial industry. This is the highest exposure to a single industry in the bank's credit operations followed by real estate with 8.5%. This is because the housing sector appears to be recovering and therefore, BAC aims to recover its real estate losses from the recovery of the housing industry. Furthermore, due to the improvement projected by the banking sector, BAC's credit exposure to the industry has increased by approximately 26% as compared to the first quarter of 2013. Similarly, the exposure to the energy sector has also increased by approximately 26%.
The banking sector is set to recover as profits are soaring and the management is making impressive decisions to maintain the growth in profitability. BAC is expected to serve as an outstanding opportunity for investors through stock price appreciation, which will occur on the basis of improved performance and recovery. The bank's extensive diversification makes it ready for any potential threats that may occur in the near term before the banking industry gains full momentum. The undervaluation of the stock will also serve as a very important factor and it will make BAC much more desirable to investors as they begin to rediscover their interest in the banking industry in the post-crisis framework.