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When Will Bank of America Rebound?

Amidst of the financial crisis in 2009, Bank of America Corp (NYSE:BAC) was arguably in the worst financial distress among banks with assets greater than $50 billion.  In 2009 Bank of America had a 5.3% loan loss provision, higher than the 5% of JP Morgan Chase & Co. (NYSE:JPM), and the 2.9% of Wells Fargo & Company (NYSE:WFC), indicating that Bank of America expected to have extremely risky loans.  Bank of America’s net interest margin in 2009 was also among the worst at 2.57%, proving that the company wasn’t making the soundest investments.  While JP Morgan and Wells Fargo were able maintain a positive return on assets for 2009, Bank of America’s ROA ended 2009 at -0.10.   Banks are expected to be amongst the best investors, and these ratios show that Bank of America’s investments did not compensate for their risks.  The company’s liabilities exceeded the amount of cash available; Bank of America Corp (NYSE:BAC) had the largest capital risk among banks with $50 billion in assets in 2009 and needed a bailout.

Bank of America Corp (NYSE:BAC)

To measure how Bank of America Corp (NYSE:BAC) has rebounded after bottoming out in 2009, historical data is a good benchmark.  However, the historical data must be independent of the crisis, and cannot incorporate data that directly led up to the crash.  In gauging Bank of America’s recovery, I used data from 1993 to 1996, where the number of houses sold had a direct relationship with the number of houses for sale.  This time frame was used because the housing bubble played a large role in Bank of America’s financial performance, and there was a small spread between homes sold and homes for sale, which is reflective of today’s market.  Although Bank of America has segments that branch off into nearly every facet of financial services, home sales are often a good lagging indicator of the overall economy and were representative of Bank of America’s financial strength.

Bank of America

From 1993 to 1996, Bank of America’s loan loss provision averaged 0.4%.  Since 2009, the bank’s loan loss provision has incrementally decreased from 5.3% in 2009, to 1.5% in 2011.  The incremental decrease signals that Bank of America has weathered the worst part of the storm, but their loan loss provision remains higher than in 1996, because it is necessary for the bank to be over-prepared in case of loan defaults.  Between 1993 and 1996, Bank of America’s ROA averaged 1%.  From 2009 to 2011, ROA has slightly improved from -0.1% in 2009, but still hovers around 0%.  Net interest margin averaged 3.5% between 1993 and 1996.  This ratio sank to 2.6% in 2009, and rebounded up to 3.2% in 2011.  It’s evident that Bank of America has slowly improved their financials since the market crashed in 2009, but they have work to do in order to reach the level of stability the company displayed from 1993 to 1996.

Bank of America Corp (NYSE:BAC) may have safely escaped the weight of billions of dollars in historical mortgage-related liabilities, but they still have a ways to go to attain an acceptable level of profitability.  The mountain of mortgage debt was transferred to Bank of America through their 2008 acquisition of Countrywide.  Countrywide originated more than $2 trillion in mortgages between 2004 and 2008.  Bank of America couldn’t have picked a worse time to acquire Countrywide, because in 2009 a large amount of those mortgages defaulted.  Through 2012, various mortgage owners are attempting to recover their losses, alleging both violations of representations and warranties.  Half way through 2012, Bank of America had reserved over $15 billion against potential representations and warranties.  This amount should be sufficient to cover most remaining mortgage exposure, but new claims against the bank and unpredictability of court decisions reduce our confidence.

Assuming that earnings improve and the company slowly pays off legal claims, they should be able to escape the need to raise equity capital, but the bank must increase capital levels in the next few years in order to comply with Basel III.  Basel III will require banks to hold 4.5% of common equity (up from 2% in Basel II) and 6% of Tier I capital (up from 4% in Basel II) of risk-weighted assets.  The massive size of Bank of America often makes it difficult to change company policies quickly, and their size brings other benefits and drawbacks.  Its size gives the bank economies of scale benefits, as well as increasing switching costs as more and more products are provided to customers, but institutions able to provide all the services that Bank of America provides are almost impossible to manage.

With an $87 billion market cap, and various segments, it’s often difficult to focus on the details in every segment.  Bank of America has made a push to get the details right.  Their attention to detail was shown in an August 29, 2012, press release about making checking disclosure clearer to customers.  As part of its ongoing commitment to clarity, Bank of America announced it is launching a new Checking Clarity Statements, that provides information about key fees and policies to each consumer and small business checking account in a clear and easy-to-read two-page format.  Customers want clear and easily accessible information about their accounts so they can make the right choices.  “By adopting the disclosure box, Bank of America is demonstrating that they understand the importance of being transparent with consumers,” said Susan Weinstock, director of Pew’s Safe Checking in the Electronic Age Project. “Now, more Americans can obtain essential financial information in an easy-to-understand format. We urge other financial institutions to follow suit.”

Warren Buffett’s hedge fund, Berkshire Hathaway is the largest Bank of America Corp (NYSE:BAC) holder.  Since the beginning of 2012, Buffett has increased his position by nearly 30 million shares.  Warren Buffet stated in his 2011 annual statement that he believed that he made some horrible investments in real estate.   In 2010, he told investors that “a housing recovery will probably begin within a year or so.” He was dead wrong.

Buffett still remain confident about the housing market stating “housing will come back – you can be sure of that.  Over time, the number of housing units necessarily matches the number of households (after allowing for a normal level of vacancies).  For a period of years prior to 2008, however, America added more housing units than households.  Inevitably, we ended up with far too many units and the bubble popped with a violence that shook the entire economy.”

Buffett remains optimistic about the American economy and believes when the housing markets recovers, unemployment will drop.  He does not know when that will happen, but he strongly believes that “America’s best days lie ahead.”  With Buffett’s optimistic view on the housing market, and his strong position in Banks of America, we believe that both the housing market and Bank of America will continue to make a slow recovery.

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