The recent financial crises proved to be a hard challenge for financial companies. Some giants fall into the hands of bankruptcy. Some of them were left at the mercy of the government bailout. Some were forced to engage in takeovers. Bank of America (NYSE:BAC) falls into the last category. The takeover of Merrill Lynch created a gigantic financial institution. The post-crises Bank of America is now much bigger and complicated at the same time.
After the merger, Bank of America surpassed JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C). It became the largest U.S. bank with billions of assets. The mortgage operations, wealth management, brokerage, credit cards, investment banking and deposit base are among the largest in the United States. The acquisition of Countrywide Financial was a cheap deal on the surface, but things were more problematic than they look on the paper.
Bank of America was built through acquisitions over several decades. But, I think the company grew too big, too fast. Many credit institutions were not properly integrated within the group, and the bank came dangerously close in many cases to disastrous losses. The seemingly cheap acquisition of Country Financial Mortgage cost Bank of America more than $2.5 billion in additional costs. Some banking segments are still problematic with numerous non-performing toxic assets. The mortgage related issues exposed Bank of America to potential customer disputes that could imply billion dollars damage payments.
You might find some reports that Bank of America and Citigroup have hidden "by mistake" debts of several billion dollars. While the reports might be exaggerated, there is some truth. In fact, the balance sheets are so complicated; it is really hard to understand what is going on with the company.
Starting from last year Bank of America engaged cutting several jobs. It closed several branches, and sold some of its assets to prepare for tighter Basel III rules. The cost reduction measures are expected to continue as Bank of America announced 30,000 jobs cut in order to reduce costs. In fact, the company declared its intention to cut costs with five billion dollars a year by 2013. While I doubt about the $5 billion effect, if that happens, the profit margins will be extremely lucrative.
The restructuring program is focused on cost-cutting measures. It might have some negative sides as the company might lose its leading status in terms of assets, employment and mortgage services. However, recent experience suggests that simplicity is the key to success. The banking rules and regulations are getting tighter all around the world. The U.S. banks should move in line with the worldwide trend that large banks should simplify their operations. The restructuring and the cost reductions aim to revive the institution, whose shares fell nearly 50% in 2011.
JP Morgan vs. Bank of America
Meanwhile, Bank of America lost the leading institution position to the JPMorgan rival in the last year. In the third quarter of 2011, JPMorgan's assets increased by 1.9%, reaching $2.290 billion at the end of September, while Bank of America's corresponding value declined by 1.8% to $2.220 billion dollars. Thanks to its conservative position, JPMorgan did not record any losses during the financial crisis, even though it saved Bear Sterns from bankruptcy and took over Washington Mutual.
In terms of dividends, JP Morgan shareholders are much happier. The group increased the dividend from five cents to 25 cents per share. At the same time, Bank of America announced that FED turned down its request to raise its dividends. The current yield of JP Morgan is 3.3%, whereas Bank of America offers a paltry yield of 0.5%.
Table 1: Stock price dynamics in 2011
2011 Stock price change
Wells Fargo (NYSE:WFC)
Morgan Stanley (NYSE:MS)
Goldman Sachs (NYSE:GS)
Bank of America
Source: S&P Capital IQ.
Last year was a horrible one for financials. A comparative analysis of DOW's returns (5.5% gain) and Bank of America's values places the latter in the top losers. JPMorgan, the only other banking institution component of DOW 30, was the fourth worst.
Warren Buffett's Position
The Berkshire Hathaway's (NYSE:BRK.A) investment of $5 billion in exchange for preferred shares with an annual 6% dividend (or in equivalent $300 million) boosted the public and market confidence in the bank's health and soundness. The immediate effects were reflected in the stock price dynamics, which for weeks had been on a downward trend. The vote of confidence given by Buffet's investment inspired the banking community to look at the institution from a different perspective. However, despite these positive signs, fears and uncertainty about another economic recession and the issues of the Greek sovereign debt crisis adversely impacted the bank's evolution. By the end of 2011, the stock was trading for as low as $5. The market cap was as low as $50 billion. At some point last year, BAC shares traded at about 0.3 of the book value, which has never happened ex ante the crisis, not even once.
At the end of last year, S&P downgraded several banking institutions, including Bank of America, JP Morgan Chase, Citigroup, Morgan Stanley, as well as Goldman Sachs. Normally, that is horrible news for shareholders. However, the stocks did not respond the negative event. Instead, they showed resistance to bad news. Realizing that even the downgrades cannot further press the financials, I suggested them as strong buys. Bank of America was among my top picks as it suffered the highest losses. Since then, the stock moved up substantially. With a year to date return of almost 50%, it is one of the top performers in the market. While, the recent news from Europe is not appetizing, I believe the U.S. economy is strong. The risk is still high, but the rewards can be substantial in this industry. Buffet's substantial exposure to financials is another reason to consider investing in this industry.
BAC data by YCharts
After all, the banking system is being undervalued due to high uncertainty. Federal Reserve stress tests of 2012 indicate a relatively strong position of Bank of America. Apparently, for many alternative scenarios, Bank of America is safer one than Wells Fargo , another Buffett favorite. Even if that is not monumental news, it offers another reason to consider Bank of America among financials. According to fellow SA contributor, Any Batts, Bank of America could be one of the top contributors to earnings increase for the S&P 500 index at the company level. While I think the top contributor will be a company from the technology sector, I also agree that Bank of America might report a record profit by the next year. I think this is one stock to watch for big moves in the second half of the year.