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Consumer Banking constitutes 40% of the Trefis price estimate for Bank of America's stock.
Corporate & Commercial Banking constitutes 22% of the Trefis price estimate for Bank of America's stock.
Wealth Management constitutes 15% of the Trefis price estimate for Bank of America's stock.
WHAT HAS CHANGED?
In Q4 2020, Bank of America reported Total Revenues of $20.1 billion, which is 10% lower than the year-ago period. Global Markets grew by 14% y-o-y due to jump in sales & trading revenues and investment banking fees. However, this growth was more than offset by a 13% drop in consumer banking and a 5% decline in the global wealth & investment management segment. Notably, the bank's net interest income for the quarter decreased by 16% y-o-y due to lower interest rates.
Impact of coronavirus outbreak
Businesses suffered heavy losses in 2020, which shifted their focus from long-term to near-term survivability. On the same lines, there was a drop in consumer demand as people refrained from discretionary expenditures. The economic downturn negatively impacted the loan repayment capability of business and individuals. This could have resulted in sizable losses for the bank, as it has a substantial loan portfolio of both consumer and commercial loans. Hence, Bank of America significantly increased its provisions for credit losses to cater to that risk. Further, Bank of America is heavily dependent on net interest income, which has suffered due to lower interest rate environment.On the other hand, Bank of America generated positive growth in Sales & Trading and investment banking businesses, due to higher trading activity in the market and jump in underwriting deals volume.
The Bank reported Q2,Q3, and Q4 2020 results on the similar lines, leading to a 6% y-o-y drop in its full year 2020 revenues.
Further. we believe that Q1 2021 will further confirm this reality with a drop in core-banking revenues as compared to the previous year.
POTENTIAL UPSIDE & DOWNSIDE TO TREFIS PRICE
Below are key drivers of Bank of America’s value that present opportunities for upside or downside to the current Trefis price estimate for Bank of America:
Sales & Trading
Yield on FICC Trading Assets: Bank of America’s trading yield has been around 6% over recent years, after recovering from lows of -4.6% in 2008 at the peak of the global economic crisis. While we estimate yield figures to be around 4.75% going forward, if the division sees a worse-than-expected performance in the coming years, the yield could decrease to 3% over the Trefis forecast period. If that were to occur, there would be a downside of 2.5% to the Trefis price estimate.
Investment Banking EBT Margin: Bank of America’s investment banking business reported margins of around 30% over 2013-2015 before jumping to almost 37% in 2018 from upbeat FICC trading activity. We expect the margin figure to remain largely around 35% going forward. However, if these margins fall to 30% over our forecast period, then there would be a downside of about 3% to the current price estimate.
Wealth Management EBT Margin: Bank of America’s wealth management business is critical to its overall business model, as it leverages the bank’s strong retail banking presence to cross-sell additional services to existing customers. The wealth management division reported a steady improvement in margins from around 16% in the wake of the downturn to around 28% in 2018. While we expect the segment’s operating margin to remain between 27.5 -28% going forward, a decline in this figure from increasing competition could push the figure to 23% by the end of our forecast period. This would result in a 2% downside to the Trefis forecast price.
Bank of America is one of the leading financial institutions in the U.S. and, along with JPMorgan Chase, is one of the two largest U.S. banks by total assets. Through its operations in the U.S. and certain international markets, the firm offers a range of products and services such as credit and debit cards, mortgages, auto loans, commercial loans, investment banking, wealth management, and sales and trading.Bank of America’s clients range from individual consumers to multinational corporations, financial companies, and governments. The firm makes a significant portion of its revenue from lending activities from which it earns a net interest spread. The bank also generates non-interest revenues such as investment banking advisory fees, asset management fees, and yields on trading assets.
SOURCES OF VALUE
Corporate and Commercial Banking is the most valuable division for Bank of America for the following reasons:
High-Interest Yields in Corporate and Commercial Banking
In 2018, Bank of America’s Corporate and Commercial Banking division had over $354 billion in outstanding business loans and over $336 billion in interest-earning treasury-client assets. We expect these figures to cross $420 billion over our forecast period, and we expect that Bank of America will earn a net interest yield of roughly 2.4% on these assets.In comparison, Bank of America’s Wealth and Investment Management division had $2.5 trillion in client assets at the end of 2018 but was earning a fee representing just about 0.53% of these assets. Bank of America also had about $165 billion in private banking loans, which earned an average net interest yield of almost 3.8%. The higher interest revenues for the Corporate and Commercial Banking division is why it is more valuable to the bank than Wealth Management.
Larger Asset Base in Corporate and Commercial Banking Compared to Credit Cards and Mortgages
As mentioned above, Bank of America had about $691 billion of total interest-earning assets in 2018 within its Corporate and Commercial banking business. In comparison, the company had outstanding credit card balances of around $95 billion.
In the mortgage business, Bank of America had outstanding loans of $120 billion in 2018.
Higher Margins in Corporate and Commercial Banking due to Minimal Loss Allowances
Bank of America’s high operating margins in the credit card and mortgage business declined precipitously from 2007 to 2009 due to higher allowances for loan losses as a consequence of the financial crises. Provisions within the credit card business increased from 5% in 2006 to cross 15% in 2009, while those in the mortgage business went from 0.1% in 2006 to 13% in 2011. We expect loan losses allowances to decrease and margins to gradually improve in both businesses.In comparison, Bank of America’s margins within the Corporate and Commercial Banking division has fared much better. After declining from 58% in 2005 to about 10% in 2009, margins recovered to almost 54% in 2012 before settling at 56% over 2017-18. We expect margins within Corporate and Commercial Banking to remain much higher than those within the credit card and mortgage businesses.
The entire banking industry has come under a lot of pressure in the wake of the financial crisis of 2008-10. Rising delinquencies in consumer loans, credit cards, and mortgages have strained the industry’s revenue base and profits. We believe certain key trends will play out in the banking industry going forward:
Regulatory reforms expected to pressure revenue growth going forward
Increased regulation facing the financial services industry is likely to reduce the top line for most financial institutions. In the past, lighter regulation allowed for greater risk-taking for many parts of the businesses, which drove strong earnings. New regulations are likely to hurt larger banks such as Bank of America and Citigroup more than their smaller peers. Regulation is expected to affect the banking industry in several ways:
Banks are now required to hold additional amounts of capital which can potentially slow growth
The CARD Act passed by the Congress has clipped card income by prohibiting issuers from raising rates, fees or finance charges on existing balances or on prospective accounts in the first year
The Volcker rule has led many banks to spin off their proprietary trading businesses
Securitization has become less appealing as investors and regulators demand that banks now retain some risk
Consolidation expected to continue
As a result of the financial crisis, the banking industry saw a period of mergers and consolidation. The financial crisis has seen nearly 15-20% of the market share change hands. The banking industry continues to see consolidation in almost every aspect of the business as players try and globalize and seek scale. Customers are also increasingly becoming more risk-averse and turning to larger players with stronger deposit bases due to uncertainty. The number of operating commercial banks declined from 7,630 in 2004 to less than 5,000 in 2017.
Acquisitions have helped increase Bank of America’s market share in key areas
The acquisitions of Countrywide, Merrill Lynch, and LaSalle have increased Bank of America’s Mortgage, Investment, and Retail banking businesses. The addition of Merrill Lynch has resulted in the combination of Bank of America’s Premier Banking & Investments business to form Merrill Lynch Global Wealth Management. This addition has helped increase the number of financial advisers, assets under management, and client brokerage assets.
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