There is no shortage of negative opinions out there lamenting the failures of Bank of America (NYSE:BAC), its management, its stock performance, or even the fact that the bank will be dead money considering the interest rate and regulatory environment in which they operate. I respectfully have come to disagree. In this piece I will lay out the case for why Bank of America is a solid long term investment that I believe, as part of a long term well diversified portfolio will turn out to be a great investment for the long run.
Bank of America is one of the most prominent financial institutions when one thinks of the financial crisis. From bad press about foreclosures, to its aggressive acquisitions of Merrill Lynch, and most notably Countrywide Financial, Bank of America has a difficult recent history. Its final acquisition of Countrywide would prove to be more costly than the $4 Billion paid for the troubled lender and loan servicer. In total BAC paid over $91.2 Billion in penalties and fees, most of which was the result of the purchase of Countrywide Financial which put BAC on the hook for their misdeeds. It took BAC many years and more money than anyone thought, but it made it through the crisis, stronger than ever, and the future remains bright for BAC.
Before one engages in a series of attacks on BAC management it is important to be reasonable, thoughtful, and realistic in our analysis. Yes, Brian Moynihan is part of the previous CEO's team, and he was part of many of the transactions that caused the bank to get into trouble. However, I believe it is only fair to assess his performance as a member of someone else's strategy. In his previous roles he was working within the framework of the previous CEO's strategic plan. Ken Lewis, operated the bank in a far different manner than Mr. Moynihan is choosing to do so today.
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This must be separated from his work as a standalone CEO who is getting to chart the direction for BAC. As a standalone CEO Mr. Moynihan has had a great deal to handle. Massive law suits, government regulators, and an increasingly difficult economic and operating environment. Yet despite all of these challenges, Brian Moynihan has already put his stamp on this once strictly domestic bank. I will let him describe the transformation in his own words from an interview he gave in a recent New York Times piece.
We were never an international bank and now we are one, we were not a major investment bank in global market activity and now we are one. On the consumer side, we had been a product company that relied too much on overdraft fees, and I ended that. There are all these cultures that needed to change.
All of these changes have been instrumental in making BAC the company that it is today, which is capable of taking on any competitor in any market, and winning. Continued success in execution of the overall strategic directives is going to be imperative if BAC will be able to win for shareholders long term. Mr. Moynihans work is far from over, and as recent management changes demonstrated, he is willing to do what it takes to return the bank to historical price to book value multiples and beyond. Creating shareholder value is a function of having the right strategy and executing on it every day, BAC continues to do this.
Bank Of America Company Values & Purpose
Many believe the reason to invest in Bank of America continues to be their leverage to rising rates. While this is surely true, any investor in BAC will see a rise in the stock as a result of rising rates, this is not the main thesis. The thesis continues to be that this is a well-diversified financial institution, trading at a fraction of its true value.
In a recent piece on BAC, I stated that I was selling the predominant positions we had in JPMorgan Chase (JPM) and Well's Fargo (WFC), in favor of doubling down on our BAC investment. Since I wrote that piece BAC is up 13%, while its competitors have failed to catch up thus far. While we continue to hold both JPM and WFC, it is a much smaller position when compared to BAC. The main reason I took this action was on the basis of valuation. Wells Fargo currently trades at 1.7xBV, while JPMorgan Chase trades for 1.1xBV. I am not sure why investors would be willing to pay such a premium for these financial institutions when they can buy Bank of America for a mere fraction of its true value at 0.8x BV. It is not often that investors get an opportunity to buy a world class franchise for a mere $0.80 on the dollar. The bank continues to grow its tangible book value at an average rate of 5.5% per year, and is well positioned to continue to return capital to shareholders. BAC's dividend yield is 1.13%, while the industry average is closer to 3.1%, leaving BAC plenty of room to increase the dividend going forward. I believe that the banks capital return plans will continue to return more and more capital to shareholders when we return to a more normalized environment for the economy and inflation which will necessitate increases in rates. BAC remains positively exposed to the interest rate environment and will benefit greatly once the Fed begins to raise rates. A mere 25Bps increase in rates would create a benefit of $1 Billion to NII.
When one looks at the accounting in financial institutions, it is quite complicated. This is especially true when looking at the total value of derivatives on the financial statements which may pose an unseen risk to investors. Many believe that calculating the total Level 3 assets, or looking into the total notional values provides a complete picture of the risk inherent in these hard to value securities. But most do not know that you have to include additional information to piece together the total risk to investors from these esoteric securities. Because there is additional risk with counter parties, one must also assess the total potential future exposure to understand the complete picture on derivatives, and other difficult to value securities.
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When we look at the OCC's Report on Bank Trading and Derivative Activity we see that total notional values is declining for derivatives across the financial sector as the chart above indicates. Looking at BAC specifically we turn to the total credit to capital calculation. For the most recent period available (Q2'15) total credit to capital was 95%, down from the previous period. Compare this to JPMorgan Chase who is holding 228% of credit to capital or Citigroup which is holding 183% credit to capital. Bank of Americas total exposure continues to decline, while at the same time their capital levels have been rising for an extensive period. The ending result is a much stronger financial institution with a de-risked balance sheet, and strong growth drivers to deliver powerful earnings going forward.
In conclusion, I have always been a student of the great value investors, from Warren Buffet, to Bruce Berkowitz, to the folks over at Sequoia, and Tweedy, Browne & Co, and of course the fathers of value investing David Dodd, and Benjamin Graham and so many more. What they have all taught me, is that for a period of time, true value investors have to be willing to look very wrong, before being vindicated as correct in the long run. For years now, the market has been pricing in the worst for BAC as an avalanche of lawsuits and extensive legal costs ate away at their profits quarter after quarter. Finally, we are starting to see the tide turn, and the true power of Bank of America is shining through, as the legal costs diminish and a greater percentage of the profits are dropping to the bottom line. While it will not be a straight line up, BAC remains well positioned to produce an above average return over the long run.
BAC remains the investment of choice for those interested in taking advantage of any future increases in interest rates, as well as offering a well-diversified, and supremely positioned financial institution. For around $18 you are getting all of BAC and all of Merrill Lynch, which includes a leading wealth management and investment banking franchise, among other businesses that contribute to overall revenue. At that price it is a steal for long term investors, who can be patient and allow the market price to slowly rise to industry averages of P/BV. Recent key changes in management will lead BAC higher over the long term of that I am confident.
Bank Of America Culture
Where I would say the largest risk exists to the down side is in the short run with the Fed decision looming. I am in the minority camp that they will not raise rates, which I believe will send the financial services sector lower. But I would use this as a buying opportunity for BAC long term.
When we look at the OCC's Report on Bank Trading and Derivative Activity we see that total notional values is declining for derivatives across the financial sector as the chart above indicates. Looking at BAC specifically we turn to the total credit to capital calculation. For the most recent period available (Q2'15) total credit to capital was 95%, down from the previous period. Compare this to JPMorgan Chase who is holding 228% of credit to capital or Citigroup which is holding 183% credit to capital. Bank of Americas total exposure continues to decline, while at the same time their capital levels have been rising for an extensive period. The ending result is a much stronger financial institution with a de-risked balance sheet, and strong growth drivers to deliver powerful earnings going forward.
In conclusion, I have always been a student of the great value investors, from Warren Buffet, to Bruce Berkowitz, to the folks over at Sequoia, and Tweedy, Browne & Co, and of course the fathers of value investing David Dodd, and Benjamin Graham and so many more. What they have all taught me, is that for a period of time, true value investors have to be willing to look very wrong, before being vindicated as correct in the long run. For years now, the market has been pricing in the worst for BAC as an avalanche of lawsuits and extensive legal costs ate away at their profits quarter after quarter. Finally, we are starting to see the tide turn, and the true power of Bank of America is shining through, as the legal costs diminish and a greater percentage of the profits are dropping to the bottom line. While it will not be a straight line up, BAC remains well positioned to produce an above average return over the long run.
BAC remains the investment of choice for those interested in taking advantage of any future increases in interest rates, as well as offering a well-diversified, and supremely positioned financial institution. For around $18 you are getting all of BAC and all of Merrill Lynch, which includes a leading wealth management and investment banking franchise, among other businesses that contribute to overall revenue. At that price it is a steal for long term investors, who can be patient and allow the market price to slowly rise to industry averages of P/BV. Recent key changes in management will lead BAC higher over the long term of that I am confident.
Bank Of America Culture
Where I would say the largest risk exists to the down side is in the short run with the Fed decision looming. I am in the minority camp that they will not raise rates, which I believe will send the financial services sector lower. But I would use this as a buying opportunity for BAC long term.
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