Bank Of America: Still A Speculative Stock

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Bank of America (NYSE: BAC), JP Morgan Chase (NYSE: JPM) and Citigroup (NYSE: C) are the three largest commercial banks in the country. All were listed among the 29 institutions deemed too big to fail by the Financial Stability Board. All three took their hits in the recent recession, and are at various stages of recovering from that era. I am going to take a closer look at Bank of America today, seeing what is new with only a few weeks left before it releases first quarter earnings.


Citigroup was not the only large bank to present at the March, 2012 Citi Financial Conference. Bank of America gave a thorough presentation as well. Unlike Citigroup's presentation on March 7th, which contained generous commentary, Bank of America's March 8th presentation was largely charts and graphs, with essentially no commentary. I will provide the commentary in the paragraphs below.


The good news for Bank of America of late is that its 2011 focus on building capital paid off, and in early March it passed the Federal Reserve's “stress test.” The bad news, is pretty much everything else going on with the company's finances. The company's highlighting of its nationwide reach is nice, but the focus it had on market leading positions in Florida (a 19% market share) and California (a 26% market share) helped to bury the company as those two states were among the leaders in mortgage foreclosures throughout the entire mortgage crisis.

Late last decade Bank of America rocketed to a ranking of the largest bank in the country, largely though its purchases of Countrywide Financial and Merrill Lynch in 2008 and 2009, respectively. The lesson is that growth, for growth's sake is of no value to anyone. I was glad to read in the presentation of a proclamation that Bank of America was committed to profitability rather than growth. Yet, those are words alone.


Bank of America has undertaken two detailed strategies to create a profitable overall enterprise. First, it aims its headcount by 30,000 jobs, in an effort to cut annual spending by $5 billion by the end of 2013. The project, known as “New BAC”, is not nearly enough. In 2011, non-interest expenses of $80.3 billion, while down about $2.8 billion from the 2010 level, still represented an atrocious efficiency ratio of 0.85. Dropping another $5 billion off of expenses would only drive the ratio down to 0.795. Either a huge increase in revenues or a much larger cut in expenses is necessary.


The revenue side of the equation of Bank of America's ledger is every bit as depressing. The loan portfolio has not actually grown for five years, and with the flattening of the yield curve, Bank of America's average net margin in 2011 fell a substantial 30 basis points from 2010, to 2.48%. Absent a substantial change in long term interest rates, Bank of America's margin will not recover; all the more important to find other ways to grow revenues, either by significantly growing the loan portfolio, or finding other ways to grow its non-interest revenues.


Bank of America/Merrill Lynch's massive retail arm is performing well enough. But since it is unable to pay back end bonuses like a Goldman Sachs, it has been forced to pay heavily for front end bonuses for top talent. The investment bank should recover from the current cyclical low in the second half of 2012, and lend a hand to earnings comparisons. Will that be enough to offset the inevitable continuation of fines, lawsuits and investigations that continue to dog Bank of America and stemming from its purchase of Countrywide? My impression is “no.”


To address the revenue issue, Bank of America has plans on hiring a thousand or more small business bankers by early 2012. The company knows well that ongoing expenses and revenues are not in sync. I just question whether management has the willpower to drive the efficiency ratio down to the 60% range where it belongs.

I do not expect much in the way of earnings from Bank of America in the first half of 2012.  The company only managed to earn one penny per share in 2011 by selling billions of dollars of “non-core” assets, and benefiting from $15 billion less in loan reserves in 2011 than in 2010.  There is no chance of a similar decline in the loan loss provision in 2012, and the easy asset sales are all behind Bank of America. Analysts see earnings of $0.12 in the first quarter, and I would be surprised to see that occur. But whatever number is released in mid-April, I will be looking past that number for meaningful revenue increases and expense reductions.


Bank of America's chief competitors are, of course, Citigroup and JP Morgan. These two money center banks have their own sets of issues, though neither as severe as Bank of America's. A large percentage of J.P. Morgan's earnings come from its global investment bank, and that part of the business is in the midst of a cyclical low point. I am optimistic market conditions will improve markedly by the second half of this year, and whenever that improvement occurs, JP Morgan's profits will get a huge lift. Citigroup all but wiped shareholders out with its one for ten reverse stock split last year, and I wonder if it will ever again show the profitability it had prior to the recession.


My own advice is that while Bank of America suits some speculators, the vast majority of investors would do well to pass over all three of these banks, and seriously consider any of several large Canadian banks particularly suitable to conservative or income oriented investors.

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