BOA/Merrill Lynch, Countrywide

Even with a solid 4Q15 of an upbeat EPS, in–line expenses, and strong loan/deposit growth, it couldn’t get Bank of America’s stock (NYSE:BAC) out of the historical slump.  BAC is currently traded at 30% lower than the 52-week high, 20% discount of its tangible book value, and less than half of its 2008 level.  Given the estimate that the US economy will grow over 2% this year, the decoupling between bank stocks and the fundamentals, a phenomenon spreading among many of the largest 10 banks, seems excessive.

The common reason cited for the industry-wide underperformance is a diminishing probability that multiple rate hikes are in sight.  As banks are in the business of making money from risk premium, the notion of pro-longed near zero interest rates certainly is not something banks want to hear.  Low interest rates will only squeeze bank’s interest margins and earnings.   In addition, neither a continuing weak oil market leading to energy credit loss, nor a slow global economic outlook would sit well with any money-center banks.

Aside from a negative macro picture, for the past decade, Bank of America has been known not to be run well.  It continues to generate subpar profitability.  It would have been de facto failed during the financial crisis if not for the assistance of the federal government.  It constantly remains under the strong scrutiny of the regulators.  On April 13, 2016, the Federal Deposit Insurance Corp. and the Federal Reserve Board had found two areas of Bank of America’s  2015 “living will” that aren’t up to par.

First, the agencies found a “deficiency liquidity problem,” that the bank does not have acceptable models and processes for estimating and maintaining sufficient liquidity. The other deficiency lies in the company’s governance mechanisms.   Bank of America, along with four other large banks, is required to provide new resolution plans by October 1.

However, it is eight years after the financial crisis.  It is six years after the Dodd-Frank Act.  Today, all big banks, albeit bigger, are under much tighter scrutiny.  We still have, on average, one bank closed every day just like the last 60 years.  Any surviving banks need to be big enough to get access to the public capital market in time of confidence crisis, so a taxpayers’ bailout like 2008 won’t happen again.

That being said, some may still be tempted to draw a parallel from 2008’s bank exposures in mortgage loans to today’s exposures in energy loans.  As the numbers bear out, today’s banks’ energy loans are just 1/14 of the mortgage loans on bank balance sheets at 2008.  Oil prices started showing signs of rebounding. While significant energy loan defaults are forthcoming, we estimate the negative impact on banks will not amount to a historic proportion.  The risk diversification strategy has insulated Bank of America from extreme exposure to the energy industry.  Though the company has lent over $21 billion to the energy sector as per 4Q15, it amounts to 2.4% of its total lending, compared to 5.4% for Morgan Stanley and 3.3% for Citigroup. BAC’s energy-related lending exposure seems smaller and higher quality than other money-center banks.

Just when most banks thought they have reduced their exposure to the energy sector, they find their balance sheets being exposed to more of it.  Similar to 2008’s mortgage loans’ evil twin, home equity lines, this time, it is the unfunded revolving lines of credit (revolvers) that  banks extended to oil and energy related companies when times were better. Ten largest U.S. banks just disclosed that they have $147 billion in unfunded revolvers, which are waiting to expand or explode their exposure to the energy industry.   Fitch Ratings is expected to announce later this week that nearly two-thirds of energy loans that are either unrated or rated as junk will be classified as “in imminent danger of default.”

The real question is how much these phantom revolvers total.  Wells Fargo admitted that its present loans to the energy industry totals $17.4 billion; but when revolvers are added in, the bank’s total exposure jumps to $42 billion. Citigroup has $58 billion; JPMorgan Chase, $16 billion; Credit Suisse, $9 billion; BNP Paribas, $38 billion; and Bank of America, $43.8 billion. In total, more than $250 billion d is exposed to the industry as of the end of 2015 according to federal bank regulators.  Christopher Helman has estimated that if the oil crunch continues to another year, “we could be looking at something in the neighborhood of $75 billion in oil and gas credit losses.”

On the other hand, the cheerleaders of BAC stress on BOA’s recent aggressive cost and expense cutting, and finally left the “Countrywide” nightmare behind.  Both trading income and investment banking volumes are expected to rebound with capital market recovery.  Bank capital ratios remain high and above requirements for almost all banks.  Bank of America continues to see efficiency gains and improvement in consumers.   The expected credit loss in the energy sector seems contained.   Of course, additional rate hikes always help!

Today, Citigroup is traded at a price-to-book ratio of 0.7; JPMorgan Chase at 1.2; Bank of America at 0.8; and Wells Fargo at 1.7.  However, it is irresponsible to recommend BAC or C a short-term buy just because it is trading at a fraction of their book values– so it will revert back to the mean of 1 time the book.  Nor should you buy Wells Fargo or JPMorgan Chase as a long-term investment for its higher valuation — as if indicates to a higher future growth.   Nowadays, the only blessing for BAC has to come from the Oracle himself.   Warren Buffett has recently expressed interest in exercising his option to buy 700 million shares of BAC, worth $5 billion, at the exercise price of $7.14 and the current price hovering around $13-14.  While he may want to signal that the Bank of America’s fundamental has turned the corner, but his same $5 billion in Goldman Sachs since 2008 has not seen the light of day yet.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s