What Wasn't Revealed at the Barclays Conference
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Bank of America's (NYSE: BAC) Bruce Thompson, Chief Financial Officer of the company, recently represented the nation's second largest bank at the Barclays Capital Global Financial Services Conference in New York. In what amounted to something of a series of cheerleading chants, would we really know from the presentation that Bank of America is still a fragile shell of its former self? 2006 was probably the heyday for most of the nation's largest banks, before the appearance of the mortgage meltdown that forced these banks to dramatically raise their reserves. Bank of America was about 30% smaller back then, yet still earned over $21 billion, for a 1.45% return on assets.
In the second quarter of this year, Bank of America earned $2.5 billion, or $0.19 per share. In the quarter, the bank set aside $395 million toward reserves set aside to deal with refund demands from third parties who had bought mortgage securities from the bank. In the second quarter of 2011, it had set aside $14 billion, and therefore there was a positive earnings comparison versus the loss recorded in the 2011 second quarter. While the Barclays report demonstrated plenty of positive trends, there still is no sign of the sort of profitability that used to be the rule.
The report first dealt with Bank of America's near national footprint. It has the leading market share in Washington, California, Florida, and Massachusetts, among other states, giving it an impressive “four corners” reach. As of June 30, it was the country's largest deposit bank,
The first and most important thing to Bank of America is simplifying its business that, due to a whole series of large acquisitions by prior management last decade, had become stupefyingly complex. On the mortgage side, the bank has intentionally downsized the business and wants to become more relationship focused with its own mortgage customers. It has also greatly reduced the affinity relationships of its credit card division.
Bank of America has closed about 500, or 8% of its retail branches since 2007. It has finally fully integrated its large acquisitions after nearly 4 years, eliminating nearly 150 products in the process. At the same time, the bank also has a global presence with operations in about 100 countries worldwide.
In recent quarters, Bank of America has steadily been increasing its common capital while at the same time shrinking its assets in general, and risk adjusted assets in particular. Even under the strict Basel 3 standard, the bank's Tier One Capital stood at 8.10% on June 30th. All we know for certain about capital regulations under Basel 3 is that it will be at least 7% for all banks, and up to 9% or higher for systemically important banks, such as Bank of America.
All banks have benefited from reduced credit and funding costs. Bank of America has been a standout here as it has been retiring its highest cost source of funds, its long-term debt. From about $450 billion in 2010, the debt level had fallen to $302 billion as of the close of the second quarter. Quarterly interest costs have fallen by over $600 million since 2010. Despite this expansive debt reduction, the bank maintained $378 billion in liquidity, and a time to required funding of 37 months. In all, I believe the bank's capital and liquidity are plenty strong.
Bank of America is also beginning to benefit from what will likely be the main driver of future earnings; non-interest expense cuts. Its “New BAC” has two elements, a $5 billion plan and a $3 billion plan. The larger of the two is to be completed by late 2013, and the other by mid-2015.
Over the past 10 quarters, provisions for loan loss reserves have steadily fallen providing a great deal of earnings support. Those days are pretty much over, and Bank of America is going to have to show me it is able to make substantial earnings by running its retail and wholesale banking arms efficiently and profitably. Analysts see earnings at about $0.90 per share in 2013, though I will not believe it until I see it. The one year target price of $9.32, or less than 3% above the price as I write this. There is too much uncertainty, and too little upside for me to endorse a purchase.
Northeast regional bank M&T Bank (NYSE: MTB) also presented at the Barclays Conference. It is currently basking in the glow of concluding several bank acquisitions, while at the same time launching its recent purchase of Hudson City Bancorp (NASDAQ: HCBK). Hudson City once was a proud franchise specializing in multi family dwellings in New York. Its model involved large down payments, in return for below market rate mortgage terms. In recent times, Hudson City's interest rate spread had nearly evaporated, as had its incentives to write new loans due to the relative flatness of the interest rate curve. M&T management expects the Hudson City purchase to be immediately accretive to earnings. No bank has a better record of buying low than M&T, and Hudson City had been trading for about one third of its 2009 stock price.
Otherwise, what impresses me most about M&T is the 144 consecutive quarters it has had of being profitable. Oh sure it struggled with lower profits late last decade, but since current CEO Robert Wilmers came to the bank in 1983, it has achieved annualized returns to shareholders in excess of 16%. I trust this management team to know what it is doing. It is also reassuring to know that Berkshire Hathaway (BRK-A) owns a 5.4 million share stake in M&T. The problem I have right now is the bank's valuation. It trades at a price to earnings ratio of 16.5. Its 5 year PEG is 1.7. I would wait until the price to earnings ratio falls to 14 or lower before investing in what otherwise is a top grade bank.
The Barclays event attracted a “who’s who” in the American banking world. With all these institutions reporting earnings next month, getting the opportunity to see Citigroup's (C), JPMorgan's (JPM), SunTrust's (STI) and others' managements summarize the states of their banks is always instructive. I look forward to continuing this series.
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