The market has not been kind to Bank of America (BAC) shareholders these last few months. The passing of the Credit Cardholders' Bill of Rights and the new banking regulations have made banking a very tough business to be in. Add in a deteriorating economic environment and that could spell disaster.
Here are some positive and negatives about Bank of America:
- Controlling Expenses - Bank of America recently announced layoffs of 3,500 workers. I don't see this round of layoffs as temporary, but more of a permanent restructuring in order to adapt to the new banking environment. Bank of America may add a few jobs in loan modifications and servicing. Any expense increase in those positions should be more than offset by cost cutting.
- Provision For Credit Losses - The PCL in the consumer portfolio decreased $4.9 billion in the most recent quarter compared to the same quarter 2010. The commercial portfolio saw a reduction of $1.5 billion compared to the same period last year.
- Net Charge Offs - The NCO for the most recent quarter was $5.7 billion which is a 59% improvement compared to the same quarter in 2010. The NCO for the last six months was 11.7 billion which was a 57% improvement than the same quarter in 2010.
- Trading Income - Bank of America has taken steps to exit its proprietary trading division. Bank of America has also taken steps in reducing its capital market risks. Trading income generate $2 billion in income so far this year which is almost equivalent to what it generated in service fees.
- Slow Economy - If the economy were to slow once again, Bank of America may be faced with increased charge offs across all loan portfolios. It will also be faced with a decrease in lending demand.
- Increase In Deposit Liability - This could have a large impact on Bank of America . Deposits are considered liabilities on the banks' balance sheets, so if a bank were to receive a large amount of deposits, it would need the capital to support it. This is the big problem for the banks. They currently have enough capital to support their balance sheets, but if their liabilities were to increase, they may be forced to liquidate further assets or raise additional capital, as they did during the financial crisis.
Bank of America is a short for me at this point. The economy is setting up to put pressure on earnings and it will be difficult for Bank of America to hold up. Its lending portfolio has decreased and will continue to do so in a weak economic environment. Service fee income has decreased due to changes in overdraft fees and new regulations. It is exiting its proprietary trading division, which has provided steady income during market downturns.
Banks are also faced with the possibility of increased deposits. As ridiculous as that sounds, deposits could have a large impact on Bank of America. Investors pulled a record $34 billion from domestic mutual funds so far this August and the month is not done yet. This is $13 billion less than an all time record. Bank of New York Mellon (BK) recently started charging large depositors fees to deposit their money. Yes, banks make a 10 basis point spread but when faced with larger capital requirements, banks would rather not have it.
Bank of America could be setting up for a great long term buy once again but in the meantime I see further downside. I think 15-20% wouldn't be out of the question, especially when considering its earnings risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.