The banking sector has had an extremely encouraging start to the year. Most of the stocks are up on the back of impressive performance for the year. Bank of America (BAC) is up over 9% since the start of the year, while Citigroup (C) and Wells Fargo (WFC) are up between 2% and 5%. Bank of America reported its fourth quarter earnings which surprised the Wall Street and resulted in taking the stock to its highest level since 2010. The peers of BAC are also performing well and have reported impressive earnings - however, Bank of America is currently outperforming most of its competitors.
A Glance at the Financials
Before we go into the details about the performance, let's first take a look at the earnings.
As I mentioned in my previous article, I expected the total net income for the year to be around $10 - BAC reported net income of $11.4 billion for the year, which even exceeded my expectations. However, the major increase in net income was mainly caused by non-interest income, which was $46.6 billion at the end of the year, compared to the previous year figure of $42.6 billion. Total revenue for the year was $89.8 billion, compared to $84.2 billion at the end of the last year. One of the most important items to note in the reported results was the provision for credit losses, which stood at $3.5 billion at the end of the year, compared to $8.1 billion for the previous year. The decrease in provision for credit losses shows the confidence of the bank in its credit portfolio and the quality of loans.
Pinpointing the Improvements
Banks take deposits and loan money to individuals and businesses - while, non-interest income is important, the core business of any bank is the interest income, the spread between the deposit rate and the lending rate. In case of BAC, net interest income grew by over $1.5 billion during the last year. Now, the amount might look small taking into account the size of the business; however, I believe the growth is impressive in the current macroeconomic environment. We can expect a larger increase in the future as the interest rates are likely to rise, which will result in a higher spread and higher interest income.
Net income from the consumer segment increased by more than $1 billion, but the increase was mainly caused by lower provisions for credit losses. However, average loans for the segment decreased by about $9 billion. Despite a substantial decrease in loans, the bank was able to maintain its income, which is extremely impressive. On the other hand, deposits were higher for the year compared to the previous years. The increase in deposits, however, did not increase the interest expense due to shift in the deposit mix and a decrease in the rate. The average rate paid on deposits declined to 8 basis points from 16 basis points for the same period last year. Furthermore, almost half of the increase in deposits ($20 billion) came from the transfer of funds from Global Wealth and Investment Management (GWIM). Real estate segment recorded narrower losses despite falling demand for mortgage refinancing.
Global Wealth and Investment Management segment preformed exceptionally well and the income from this segment grew by more than 32% for the full year. Revenues from this segment also went up by about $1.2 billion. The encouraging sign from this segment is that the client base is growing - total client balances went up to $2,366.4 billion from $2,151.6 billion at the end of the last year. Furthermore, global banking segment achieved its record revenues and investment banking revenues stood at $1.7 billion.
While the growth in the core business is impressive; the growth at the expense of credit quality will never last. However, in BAC's case, we are seeing growth in revenue along with the improvement in credit quality. As a result, the growth will be sustainable and revenue will continue to grow in the long-term.
First of all, let's talk about the provision for credit losses. Banks keep a certain percentage of cash in reserves in order to cope with the expected losses on loans. A bank's provision for credit losses can tell a lot about the quality of the loans portfolio and its confidence in the recovery of those loans. A declining provision for credit losses shows that the credit quality has increased and the expectation of losses from loans has decreased. In a year, the bank has decreased its provision for credit losses by more than 56%, indicating huge confidence in the loans portfolio.
Moving onto the second item in the table - net charge-offs have also decreased by about 48%. Although these charge-offs do not include $2.3 billion worth of charge-offs for the PCI loans, the decline in charge-offs is substantial even taking into account the write-offs for PCI loans. If we include the PCI charge-offs, the decline in net charge-offs comes to be around 33%, an extremely impressive figure. Furthermore, nonperforming loans, leases and foreclosed properties have come down to $17.7 billion from $23.5 billion at the end of the last year. Net charge-off ratio is less than 1 at the moment - it is a ratio that calculates the charge-offs as a percentage of outstanding loans and leases. It means that the bank's losses on loans and leases are less than 1% of the total outstanding loans and leases.
The macroeconomic environment is becoming friendly to the banks. The increase in interest rates should allow the banks to further enhance their spread and report even better income from core operations. Moreover, improving economic conditions will certainly increase the investment and saving activities, which will result in better deposits and increased revenue from the investment segment. However, as I mentioned in my previous article, the biggest risks for the Bank of America comes from the ongoing litigation procedures. For a detailed discussion of its risks, please follow this link. Other than these risks, I do not see any major hurdle for Bank of America and I expect it to achieve substantial growth over the next twelve months.