More Bad News for Bank of America?
Bobby is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The Federal Reserve, with some assistance from JP Morgan Chase, released the results of its stress test on 19 of the nation’s largest banks and bank holding companies. I am going to look at three of the banks that passed, to show that if nothing more, passing the test is not indicative of the investment quality of the particular issue. Bank of America (NYSE: BAC) is still struggling mightily and has posted earnings recently based upon a huge variety of one time factors. Regions Financial (NYSE: RF) is selling quality assets and diluting its stock just to pay its TARP debt. U.S. Bancorp (NYSE: USB), on the other hand, is a model of efficiency and stability in the banking world.
Bank of America traces its roots to the old North Carolina National Bank, and through a long trail of acquisitions, including those of Merrill Lynch in 2009 and Countrywide Financial in 2008, became a behemoth with over $2 trillion in assets, making it now the second largest bank in the country. The big news for Bank of America is, somehow, it managed to pass the recent stress test of the Federal Reserve. Many banks are regarded by the Fed as well enough capitalized that they are welcome to go forward with plans to return capital to their shareholders. Bank of America applied to the Fed to raise its dividend early in 2011, and that request was denied. So, again, while Bank of America's Tier One capital level would remain above 5% of assets even in a substantial economic downturn, the bank did not request to return any capital to its shareholders at this time. Expect the issue to be revisited later on this year.
The investment community apparently believes the situation at Bank of America has stabilized, and has bid the stock up from just under $5 per share in December, 2011, to nearly $9 per share today. Investors were heartened, perhaps, by a profit of $1.99 billion, or $0.16 per share in the fourth quarter of 2011. This reversed a similar sized loss in the year earlier quarter. But this profit was really a simple house of cards. Bank of America's sales of its interests in Chinese Construction Bank, along with various sales of preferred and debt instruments, contributed $5.3 billion to revenues in the quarter. Also in the fourth quarter of 2011, Bank of America reserved for loan losses $2.2 billion dollars less than the year earlier. For all of 2011, reserves for loan losses were $13.4 billion, compared with $28.4 billion set aside for loan losses in 2010. So, to sum up, Bank of America resorted to $7.5 billion of onetime gains just in the fourth quarter, and still managed only to earn $2 billion. In speaking about Bank of America's fourth quarter of 2011, one analyst called the earnings report “built out of pipe cleaners and paper machet for the Wall Street Science Fair.” I agree.
Now that much of the low laying fruit has been picked, so to speak, what does Bank of America have in store for 2012 and beyond? The bank is principally focused on the reduction on the expense side of its ledger. Its “Project New BAC” aims to save $5 billion in annual costs by the end of 2013, primarily by firing 30 thousand employees. Bank of America's expense ratio for 2011 was a dreadful 0.82%. Even if that expense amount declined by $5 billion, the ratio would fall to a still unacceptable 0.76%. Expenses are a big problem for Bank of America, but not the only problem.
In today's low interest environment, expanding a bank's loan portfolio is critical. Bank of America's loan portfolio at the end of 2011 was $892.4 billion. At the close of 2010, it was $898.6 billion. Small wonder that interest income fell on a year to year basis. Overall, Bank of America sold off $34 billion in “non-core” assets in 2011. Indeed, there is more than one way to improve capital levels, and shrinking assets is one of them.
And of course, no one knows the future course of litigation and fines concerning mortgages, most of which were tied to the Countrywide acquisition. Suits such as the one brought by MBIA, Inc. (MBI), the MERS lawsuit, and others of that group could entail tens of billions of dollars in future costs. The end of the bad news on Countrywide is not yet foreseeable.
For those reasons, I overlook the fact that Bank of America is selling still for far under its tangible book value, and conclude that while Bank of America is a fine choice for a speculator, it is a miserable choice for an investor in light of more logical choices out there within the banking sector, one of which I am going to take a quick look at now.
While U.S. Bancorp may not have the scope of its larger money center peers, it has purchased more distressed banks (14) via FDIC assistance than any other institution. So while other banks have intentionally shrunk their asset bases (hello Bank of America), U.S. Bancorp grew its assets by 8%, or $28 billion dollars during 2011 to end the year with $335 billion in assets. It, to absolutely no one's surprise, also passed the Federal Reserve's stress test, and received permission to more than double its dividend, to an annual $0.78 per share, thus raising the effective yield to 2.5%. The bank also announced, what in my opinion is an ill-conceived, 100 million share buyback. I am thankful that the amount is not higher, as US Bancorp stock is selling for about twice its book value. I would rather see that money be used to create revenues and profits for the company.
U.S. Bancorp's full year 2011 return on assets of 1.53% and efficiency ratio of 0.50% are both top notch. To some, it might appear that there is nowhere left to go for the company since it appears it is already hitting on all cylinders. But prior to the recession, from 2004 – 2006, U.S. Bancorp recorded a return on assets in excess of 2% each of those three years. I have thought of U.S. Bancorp as the top holding in the banking sector for some time. But its stock price is up by over 50% in the past six months, and there is not the upside there used to be. There is, however, at last an average dividend, tremendous management, and a bullet proof balance sheet. U.S. Bancorp is a fine choice for conservative, long term investors.
Another large regional bank that passed stress test muster was Regions Financial. Apparently, its inability to earn a profit in any year since 2007, and the fact that it still has not repaid a dime of the $3.5 billion in TARP money it was loaned did not disqualify it from passing. It sold its Morgan Keegan brokerage to raise cash, and is near a dilutive, $900 million secondary common stock offering as well. Passing the stress test is not an endorsement from an investor standpoint obviously. I distinguish between speculators and investors. I do not believe Regions is suitable for either.
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