Business Analysis
When current CEO Brian Moynihan took over in 2010, Bank of America was a catastrophe. Under previous CEO Ken Lewis, the bank acquired both Countrywide Financial (the home mortgage originator) and Merrill Lynch; two decisions that Morningstar’s senior banking analyst Jim Senegal dubbed “some of the worst capital allocations decisions of all time”.
Mr. Senegal isn’t being hyperbolic, as Countrywide and Merrill Lynch ended up exposing Bank of America to over $200 billion in legal fines, compliance fees, and enough exposure to toxic debt that it nearly bankrupted the company.
Fortunately, Brian Moynihan is a completely different banker than Ken Lewis (who was a huge fan of risky speculation in highly leveraged mortgage backed security derivatives and credit default swaps), who has spent his tenure laser focused on creating a far more conservative banking culture.
This can be seen through three major initiatives:
First, Moynihan sold off much of the bank’s underperforming business segments to focus on the bank’s core businesses, which allowed for massive cost cuts. However, unlike many banking rivals, Bank of America has spent the last six years trying to build a permanently leaner corporate culture, as seen with management’s ongoing $3.3 billion in annual cost savings the bank is targeting by the end of 2018.
Even more importantly, after the trauma the entire banking industry experienced in 2008, Bank of America has focused on creating a fortress-like balance sheet, one strong enough to withstand an economic shock even worse than the Great Recession.
As you can see, Bank of America’s Basel III common equity Tier 1 capital ratio (the most conservative form of comparing a company’s working capital to its risk weighted assets) has been steadily climbing over the years. In fact, since 2010, under Moynihan’s leadership the ratio has risen 55.2% from 7.6% (very weak balance sheet) to 11.8%.
Source: Bank of America Earnings Presentation
Current Federal regulations dictate a minimum of 8% to ensure a bank can remain solvent (and avoid needing a federal bailout) even during an economic shock. In order for a bank to be allowed to return capital to shareholders via buybacks and dividends, a bank needs to prove that doing so won’t result in its reserve capital being too weak to survive a worst case economic scenario.
The scenario that was tested most recently modeled a far more severe and prolonged recession than what we experienced in 2008-2009 (when GDP declined peak to trough by just 5.3% and unemployment peaked at 10.0%).
Bank of America Corp (NYSE:BAC) passed this year’s stress test with flying colors. In fact, the bank even managed to meet the minimum 8.0% CET1 ratio minimum, which indicates that it could have continued to pay its current dividend during the hypothetical economic turmoil.
