- BAC outclassed its competitors by posting higher top line growth, except Goldman Sachs.
- Strong rebound in merger & acquisition activity, along with the increasing fee trend in the US, are likely to benefit the bank.
- Although the low interest rate environment hurts the bank’s interest yield, it creates business for the bank’s underwriting segment as companies look forward to raising more debt.
- The hype of litigation issues faced by the bank has depressed the stock price, ignoring the improving fundamental indicators. Thus, creating an opportunity for investors to enter.
Amongst the too-big-to-fail banks, Bank of America Corporation (NYSE:BAC) outclassed the major players in the banking industry by registering a 17% growth in its top line, apart from Goldman Sachs (NYSE:GS). The financial institution has been the topic of discussion for quite some time now due to its litigation issues that continue to tarnish the bank's image. In fact, I believe that the bank's financial prospects as a financial institution have been hemmed in by litigation flashbacks.
Let's take a look at the hidden picture.
Interest Yield Continues To Get Hit
Source: 2014 Earnings Presentation
The minute 3 basis points decline in the bank's net interest yield was mainly attributable to the two few interest accrual days, lower consumer loan balances and yields which were partially counterbalanced by improving long-term debt costs and lower deposit pricing. The bank is making strenuous efforts to exploit the benefits from other activities that stand to benefit in a low interest rate environment, till the rates move higher, as discussed below.
Resurgence In Merger & Acquisition Activity
The bank was able to generate a smaller amount of revenue from the strong rebound in merger and acquisition activity level compared to its peers. However, it is expected to increase as the stringent regulatory requirements and cut throat competition prevailing in the marketplace continue to compel many companies to merge and integrate their operations to meet the regulations while beating the competition at the same time. Also, the fee pool in the US has already surpassed the peak point reached in 2007. The bank's strong presence in the US puts it in a good position to exploit this bullish fee trend.
Fed's Stimulus Creates Business Opportunities For The Bank
Just because the big names in the banking industry of America are scaling down their debt-trading desks does not mean the game has ended. There is still a lot of potential for making big bucks in the US corporate debt market which has proliferated by nearly 50 percent since the financial contagion of 2008. Since the US base rates are at rock bottom, many companies are hurrying to issue bonds to lock in low borrowing costs, as the Fed continuously attempts to spur growth in the economy for the sixth year in a row.
On average, Bank of America makes approximately $12 billion per annum from its fixed-income, currencies and commodities underwriting and trading businesses. In the light of the current herding behavior of bond issuers, the lender is expected to witness a reasonable boost in this segment's activity.
Small-dollar Credit Market: Payday Lending
Payday lending was a facility introduced by banks to beckon borrowers with promises of quick cash and less credit checks. The exuberantly high average effective interest rate (455%) that could be charged further triggered the banking sector to unleash the largely untapped ready advance avenue. Thus, the lucrative business soon became the target of intense scrutiny of the two active watch dogs; the U.S. regulators and consumer advocates. It was not only unethical on the part of the bank to exploit the needs of the customers with limited options due to their lower credibility to avail other forms of credit, it carried a very high default risk. Recently, Bank of America has joined hands with New York State Department of Financial Services to curb the practice of payday lending. Although this may slightly shrink the bank's bottom line, it will also load off the high risk assets from its balance sheet. Ultimately, the financial institution will benefit in the long term, as there will be lesser charge offs due to improving asset quality.
The Constant Hype
The media constantly keeps highlighting the wrongdoings of the bank that are all six to eight years old. The bank has learnt its lesson very well and is on the road to recovery. However, on the positive front the constant hype has depressed the company's share price and may in fact be called as a blessing in disguise for investors who are here for the long haul.
In the short term, the bank will be facing legal charges for its previous sins. However, on the back end the bank is actively working on strengthening its base as witnessed by its improving loan-to-deposit ratio, asset quality trend (see graph below), efficiency ratio etc.
Source: 2014 Earnings Presentation
Most importantly, the bank has a book to value ratio of 0.74. The good things are all out in their future. Mainly, as a value investor focused on contrarian sub-style, that is all you are looking for in the stock market.