Bank of America (BAC) has been surrounded with litigation issues for some time. Now that the legal problems are beginning to ease, Bank of America represents an excellent buying opportunity. BAC, with a cheap price-to-tangible book multiple, has also initiated an aggressive cost cutting and business streamlining program to strengthen its balance sheet.
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Bank of America Corp
BAC, with a market cap of $82b, aims to provide a diversified range of banking and non-banking services through its five business segments; Consumer & Business Banking (CBB), Consumer Real Estate Services (CRES), Global Wealth & Investment management (GWIM), Global Banking and Global Markets. Living up to its name, the Charlotte-based bank, with 5,700 banking centers, serves 57mn customers in all 50 states of the United States as of March 31, 2012. Expense control is the key area of focus for BAC this year.
BAC posted strong first quarter results, forcing analysts to increase their earnings estimates for 2012. Net income for 1Q2012 saw a significant decline of 32% to $653mn from $2.0b YoY. Driven by lower consumer loan balances and yields, the bank's fully taxable-equivalent (FTE) net interest income decreased by 12%, from $11.1b, to $1.3b. Net interest yields have continued to face pressure due to the near zero interest environment. Similarly, non-interest income also witnessed a decline from $11.4b to $3.3b over the same period. The decline in non-interest income can be attributed to a decrease in the equity investment income, and negative debt value adjustments, which were partially offset by gains on debt repurchases and mortgage banking income.
Improvements in bankruptcies, delinquencies in unsecured consumer lending and the credit card portfolio, and a reduction in the home equity portfolio drove overall provisions for credit losses down from 2.4b to 1.4b for 1Q2012. Credit losses provision related to both consumer and commercial portfolios, decreased by 50%.
The bank reported total expenses of $19.1b, including litigation expenses amounting to $0.8b. The bank initiated a project named 'New BAC', through which it aims to shed 30,000 consumer banking jobs. The bank is expected to cut up to 400 jobs in its investment banking, corporate banking, and sales and trading units, and with the expected sale of its non-U.S. wealth management unit, it will be able to get rid of another 2,000 jobs.
Segment Wise Review
A closer look at the bank's business segments revealed that the CBB segment contributed the most in terms of revenues earned, however, Global Banking had the largest contribution in earnings for the bank during 1Q2012.
A decline was witnessed in CBB's revenues and net income of 88% and 71% respectively over 1Q2011. The decline was primarily associated with a decrease in net interest income due to lower average loans and yields.
CRES, like in 1Q2011, posted a loss in 1Q2012. However, this time it was as significant. The fact that CRES remained in a loss is attributed to the continued high cost of managing delinquent and default loans. However, the improvement in the segment's results is associated to increased mortgage banking income, resulting in increased revenues for the segment and a decrease in non-interest expense and provision for credit losses.
Although Global Banking experienced a decline of 5%, its net income remained flat when compared to 1Q2011. A decline in the underwriting fees drove revenues for the segment down, which was offset by lower non-interest expense and provision for credit losses.
Net income from global markets saw a sharp decline of 43% when compared to the segment's net income in 1Q2011. The decline is associated to the debt value adjustment (DVA) loss, which occurred due to tightening of the bank's credit spreads. Improved market environment and higher trading and sales revenues resulting from fixed income, commodities and currencies, partially offset this sharp decline.
The lower non-interest expense offset effect of lower transactional activity left GWIM's earnings unchanged for 1Q2012 YoY.
Capital and Asset Base
The bank's Tier 1 common capital at the end of 1Q2012 was $131.6b, showing an increase of $4.9b from 4Q2011. Earnings, which are eligible to be included in capital, drove this change in the Tier 1 common capital. The Tier 1 common ratio, a measure of risk-based capital is up from 9.86% in 4Q2011 to 10.78% in 1Q2012. The Tier 1 common ratio is largely in line with the industry peers. Common ratios for JP Morgan (JPM) and HSBC (HBC) are 10.4% and 10.1%, respectively.
America's largest bank is betting bigger. BAC was able to increase its total asset base by 2% to reach $2.2 trillion when compared to 4Q2011.
The book value and tangible book value for the bank have continued to hover around $20.5 and $12.9 per share, respectively, for the last five quarters. The stock, with regards to its price-to-tangible book value, is trading at a significant discount of 72% when compared to the average industry peers. This reflects that the stock is trading at cheap multiples.
BAC has been pursuing a policy of decreasing its exposure to GIIPS nations (Greece, Ireland, Italy, Portugal and Spain). Its exposure, net of hedges, which was $13b in January this year, has reduced to $9.8b, showing a drop by 24%. This makes it 7.5% of Tier 1 capital. That is the reason why the recent downgrade on Spanish banks by a premier American credit ratings agency has not affected BAC's stock price much.
The company has been busy streamlining its businesses in order to focus on the core business. In this regard, it has made several divestments like selling Indophil Resources NL, Elders Limited, Beach Energy Ltd and Noble Mineral Resources Ltd during 1Q2012. It has also put on sale its non-U.S. wealth management unit, according to Reuters.
JP Morgan Chase
JPM is one of the world's leading investment banks with an asset base as at March 31, 2012 of $2.3 trillion. The bank's business is organized into two segments: corporate and private. Corporate is further divided into Investment Bank, Commercial Banking, Treasury & Securities Services and Asset Management. The bank's private business segment comprises of Retail Financial Services and Card Services & Auto segments.
Investigations are underway on a hedging loss of $2b, and its outcome could have an adverse impact on earnings and the stock price, however, but it does not represent a solvency issue for the bank. Regulators are looking into the possibility whether JPM executives have to give compensations due to the failed $2b hedging strategy.
Investigations by the Securities and Exchange Commission (SEC) are also underway to judge the appropriateness and completeness of the bank's financial reporting.
Morgan Stanley (MS)
Another competitor in the large cap U.S. Banking Industry is Morgan Stanley . MS aims to provide diversified financial products and services to corporations, governments, financial institutions, and individuals worldwide. Morgan Stanley, in wake of the looming debt crisis in the Euro zone, has reduced its exposure to GIIPS nations. It currently has a 4.5% Tier 1 capital exposed to GIPPS nations. The exposure dropped from $3b in January this year to $2.41b in March. Improvements in Morgan Stanley's risk management were also recognized by Moody's, which is why its ratings were not cut by the threatened 3 grades.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.