Mini-Research Paper on Bank of America Corporation
The following paper will follow the guidelines set out on the syllabus for the mini-research and will cover high-level corporate governance/agency conflicts, unique/systematic risk to the bank, industry risk, capital budgeting decisions, recent financing decisions, current capital structure, analysis made by financial analysts, news coverage in the media & stock prices of Bank of America Corporation. Finally, there will be a short-term and long-term of Bank of America based on the topics covered in the research.
To begin it would be useful to provide an overview what Bank of America Corporation does. Bank of America is a global financial institution, serving individual customers, businesses & institutions operating in 35 countries throughout Europe, the Middle East and Africa, Asia Pacific and the Americas. It has 5 main lines of business that include: Consumer Banking, Global Wealth & Investment Management, Global Banking, Global Markets & ALM. The Corporate alignment is shown in Figure 1 taken from the 2019 Annual Report. Note that the majority and producing lines of business are consumer related. These consist of; customer deposits, Merrill Edge (individual brokerage accounts of $250,000 or less), small business banking, credit & debit card, real estate & vehicle loans and will be discussed more in detail in the analysis section of this paper. It is also fair to note that Bank of America is a global leader in wealth management, corporate and investment banking, and trading across a broad range of asset classes. The bank provides services to corporations, governments, institutions, and individuals (newsroom.bankofamerica.com). These attributes make it one of the United States largest money center banks along with Citi, JP Morgan, Wells Fargo & others.
The size and scale of Bank of America’s operations has also shaped Bank of America’s corporate governance profile, spotlighting agency conflicts & pronouncing the need to mitigate the individual and industry risk characteristics of the bank. These factors have and can be considered in the firm’s capital budgeting decisions, finance decisions and ultimately capital structure.
The main idea behind Bank of America’s current policy & risk mitigation is responsible growth. This is a response to the 2008 Financial Crisis that saw the housing bubble burst, and Bank of America receive a $45 billion dollar bailout in the form of a TARP loan from the United States federal government. At the time, Bank of America had announced the acquisition of Countrywide Financial in January of 2008 and completed the deal on July 1, 2008 for $2.5 billion. However, according to an August 17, 2014 article by Rick Rothacker in The Charlotte Observer, has cost Bank of America $50 billion and counting in settlements, payments to investors for soured loans, accounting write-downs and operating losses. In September of 2008 Bank of America then agreed to acquire Merrill Lynch & Co. at the height of the financial crisis. As a result of these events, 2009 Financial Statement show the provision for credit losses jump from $26.8 billion to $48.5 billion and reported Goodwill of $86.3 billion and a 20-year low stock price of $3.95 in February of 2009. In 2010 Bank of America named Brian Moynihan as the CEO and began a dramatic reconstruction of the firm based on the responsible growth platform. This ideology employs four tenets as pillars for achieving responsible growth: grow by winning the market, grow with a customer-focused strategy, grow within our risk framework & grow in a sustainable manner. In order to do this Brian & the board of directors began building the governance committees that the bank has today shown in Figure 2 (taken from the Bank of America 2019 annual report).
From a high-level view, we can see that 2 board committees have been formed to mitigate enterprise risk & install corporate governance. Let us take a closer look at the risk dealt with by these committees and the industry as a whole.
The enterprise risk committee is a board committee with two management committees that report to it (management risk & regulation o committee) are both focused on mitigating the Banks’s two main risks. These main risks come in the form of government regulatory & macroeconomic risk. On August 21, 2014 Bank of America was ordered to pay $16.65 billion in a settlement for the packaging, marketing, sale, structuring and issuance of residential mortgage-backed securities (RMBS), along with questionable underwriting practices and knowingly failing to disclose key facts to investors of these products. Figure 3
This was a colossal failure to monitor, assess and mitigate the risk that managers made all along the way leading up to the 2009 financial crisis. As a result of this settlement, CEO Brian Moynihan created the board and management committees we see today and issued the 2015 Business Standards Report and Environmental, Social and Governance Addendum which set out the corporation’s current risk policy and standards for business conduct. Below is an excerpt from the 2015 Business Standards Report. Figure 4
Some key takaways from his letter are: 1) Bank of America is taking action to cut costs & become less risky. 2) The bank will transform by building up liquidity and capital levels & rebuild the Balance Sheet. 3) Resolve mortgage-related and other issues from the 2009 crisis. 4) Focus on responsible growth. Later in the analysis section we will take a look at the financials and see if Bank of America has been able to do these things.
The second main risk that affects the bank is macro-economic risk. There are 4 risk factors that affect financial services: interest rates, GDP, Fiscal policy and existing home sales. The latest FOMC announcement on interest on November 5, 2020 will keep the Federal Funds rate at 0 to ¼ percent at least until 2022, which is mixed news for Bank of America.
From the main risk second group, GDP growth affects the trading, investment banking, mortgage & wealth management lines of business. The 1st Quarter of 2020 saw the COVID-19 worldwide pandemic hit and create uncertainty for world. The result in the United States for GDP growth in Q2 was a -34% drop. A rebound in Q3 of 33.1% was promising as businesses repopened and the economy as a whole resumed activities albeit at a restricted level. See Figure 5 below taken from the Bureu of Economic Anaysis below.
Fiscal policy risk is still uncertain. 2020 saw Joe Biden win the Presidential election and his transition team has identified four priority areas: COVID-19 response, economic recovery, racial inequality and climate change. On the regulatory front, a recent article Financial Institution Regulation Under President Biden in corpgov.law.harvard.edu on November 16, 2020 by Carroll, Gilbert, Baum, Cleary Gottlieb Steen & Hamilton LLP, stated that “We expect the current rulebook to remain generally intact, with only modest modifications and a continued focus on supervision and enforcement”, which bodes well for Bank of America if it comes to fruition. The Trump administration set conditions that served Bank of America and financial institutions at large, well. Bank of America was able to carry out the goals set out by it’s CEO under Trump and would continue to do so if regulations generally stay the same.
The last risk factor is existing home sales. Astonishingly this risk factor is outperforming intuition related to COVID-19. Existing home sales has jumped 4.3% to $6.85 million in October however inventory is at an all-time low expected to last only 2.5 months according to the National Association of Realtors. See figure 6 below. This is promising news for Bank of America in 2021, with mortgage rates around 3.0% and a hot housing market.
So, what are Bank of America’s investment decisions? Let us take a look at three: invest in technology, not investing in risky assets & return money to stockholders. The first decision is to invest in technology. Figure 7 taken from the Bank of America’s 3rd Quarter 2020 presentation shows the technology that Bank of America has decided to invest in.
The main focus is on digital banking apps. Erica is a virtual assistant on the mobile banking app that is designed to function like a teller at financial centers. Zelle is Bank of America’s solution to PayPal, Venmo, etc. and also available thru the banking app. Merrill EDGE self-directed is Bank of America’s response to Robinhood Trading & a host of do-it-yourself online stockbrokers. CashPro mobile focuses on Merrill Lynch customers and allows them to make a variety of transactions from a mobile app.
The next investment decision, or decision not to invest is in risky mortgages. Looing at the 2015 ESG report in Figure 8, Bank of America has made a clear decision not to invest in mortgages originated by other lenders in order to control the credit quality of the individual loan and increase the quality of the financial assets available for sale. We will look at how effective this will be in the analysis section of this report.
Finally, Bank of America has decided to return money to investors in the form of dividends.
The last 5 years has shown increasing cash dividend payments to stockholders, except for 2019 which was $39 million less than the previous year. However, the last 10 months of 2020 is already higher than any year before.
So how is Bank of America financing their investment decisions? Let us look at the capital structure over the last 5 years. Figure 9 below, taken from macrotrends.net shows the trends in long term debt to shareholder’s equity over the last 5 years.
From the trends graph & the actual numbers shown, issuance of capital stock has varied with a low point in 2017, going back up to $4.5 billion in 2018, $3.6 billion in 2019 & $1.1 billion this year. The issuance of debt has maintained an average of $49.8 billion over the last 5 years. The last 10 months show $48.1 putting this year’s debt issuance right below the average. Below are some of the debt ratios calculated
The most recent financial statements. Long term debt to total capitalization ranges roughly from 44% to 48% and the total debt to invested capital ratio ranges from 50% to 53%. Both are pretty stable over the last 5 years. Retained earnings shows strong increase over the last 5 years from $75 billion in 2015 to $156.3 billion so far in 2020. This gives relevance to the pecking order theory which assumes asymmetric information and it’s affect between internal and external financing and between new issues of debt and equity shares…in which investment is financed first with internal funds, then by new issues of debt, and finally with new issues of equity. (Ch. 18, p. 495) Meaning that Bank of America should have plenty of good projects to finance due to its high retained earnings over the last 5 years, or at least enough funds to finance the projects.
Analysts seem to agree with what I have found. That Bank of America is accomplishing the dramatic reconstruction set out in 2015. Here are just a few of the analysis reports I found on finance.yahoo.com. Figure 10 shows that Bank of America is outperforming the sector in innovation. Hiring is at the sector average, insider sentiment is good, Bank of America has beat earning expectations for the last 4 quarters except for Q12020 which saw the outbreak of COVID-19. Most analysts rate the stock as a hold or a buy.
My long-term determination is based on Bank of America & it’s CEO’s ability to accomplish two items set out in 2015 ESG report. 1) Has Bank of America taken action to cut costs & become less risky? 2) Has the bank transformed by building up liquidity and capital levels & rebuild the Balance Sheet? I believe it has. Here are some metrics I have based my determination on. Figure 12 shows that over the last 5 years Bank of America has cut costs & become less risksy. Net income has increased over the last 5 years,
while expenses have decreased, due to better performance and this way improving efficiency ratios. Bank of America is continuing to improve on it’s charge offs & improve total shareholder return as shown in Figure 13.
Lastly, it has cleaned up its balance sheet and improved it’s liquidity and capital ratios.
Consequently my 2 to 3 year assessment of what the firm will be like is much the same. I believe that Bank of America has made a commitment to all of the points I have discussed to the long term. As long as the regulatory environment remains unchanged, corporate tax rates do not go up and the economy resumes pre-pandemic levels, things look good for Bank of America.
My 3 to 9 month assessment is very inconclusive. I think that the stock will continue to trade at the $29 level until mid-January. Coronavirus outbreaks will increase from the end of 2020 until the Spring of 2021, keeping Bank of America in a holding pattern until then. The Biden administration may bring some influential changes, the most important being economic stimulus packages.