Banking Sample
The banking industry, over the last decade has undergone significant change. Industry regulation such as Dodd-Frank, Basel 3, and international capital requirements have now made the industry safer and more transparent. However, due primarily to the crisis of 2008, some banks are more stable than others. In many instance, due to unethical practices of the past, many banks are now suffering as they struggle to attract market share and consumer acceptance.
To begin, let's start by dispelling many myths associated with Bank of America. First, the bank did not single-handedly start the financial crisis as many pundits believe. They much like many of the other large banks did have a part in the crisis. However, they were not the sole owners of the problems that resulted from it. This is an important distinction as Bank of America's market valuation and profitability have been significantly effected by perception rather than reality. The perception that the bank will become insolvent has led to many of the low financial metrics used throughout this document. In addition, due to negative consumer sentiment, the bank's overall evaluation is significantly lower than those of its peers in the industry (Unknown, 2008).Second; Bank of America did not partake in many of the subprime lending behaviors that many of the banks peers did. However, it acquired a firm that did indeed participate, in a substantial manner, in subprime mortgage lending. Countrywide, was a large player in the subprime market and as a result of the BAC acquisition, the overall company was pierced to have single-handedly cause the crisis (Hector, 1988). These two myths will provide the foundation by which a large portion of this document is based on. Perception vs. reality will be a common theme in this document as I juxtapose the actual financial results of those of many of the banks peers in the industry.
To begin, BAC's performance in regards to profitability directly corresponds to that of the overall economy. This is particularly true, as the mortgage market has declined so substantially from its 2008 peak. In many markets around the world, home prices have yet to catch up to their 2006 peaks. This bodes well for the overall economy as there is substantial demand for housing related products. As such BAC stands to profit substantially from this trend. First, the company has 10.3 billion shares outstanding. Recently, the Fed approved a $5 billion dollar buy back for the company's shares. At an approximate market price of $14 (The stock today is at roughly $12), the company could purchase approximately 356 million shares or 3.6% of the company. Historically, the company has been able to earn $20 billion annually. This equates to roughly $2 a share in earnings power for a company that is trading in the market for $12. This seems almost too good to be true, and it is. Investors and the community at large believe that BAC will be unprofitable for years to come as indicated by the lower market price relative to the company's earnings power. However, the company is poised to deliver strong profitability numbers for years to come.
Bank profitability is determined in large part by interest rates. Currently interest rates are at historic lows. To aid the economy, the Fed has been keeping its target rate for overnight loans between banks near zero. The effects of the accommodative policy can be seen in the latest quarterly reports. Net interest margins -- the difference between what it costs banks to raise money and what they get for lending and investing it -- fell by 26 basis points, to 3.06%, at JPMorgan from the first to second quarter; 17 basis points, to 3.15%, at Citigroup; and 16 basis points, to 2.77%, at Bank of America, according to company reports. These declines in a margin are directly correlated to profitability. The reduced margins contributed to a drop in net interest income of $1.02 billion at JPMorgan, the second-largest U.S. bank by assets. It fell $849 million at Bank of America, the biggest lender, and $522 million at Citigroup, which is third. Wells Fargo, the fourth-largest bank, reported that net interest margin actually increased by 11 basis points, to 4.38%. This could be attributed to the large volume of mortgages at WFC.
Bank of America Chief Executive Officer Brian T. Moynihan told analysts on a July 16 call that the sustained low-rate environment was hitting revenue and earnings and will continue to affect margins. JPMorgan CEO Jamie Dimon told analysts the day before that the bank's net interest margin will continue "coming down a bit as we reposition...
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