Why I Bought More Bank Of America (BAC)

Why I Bought More Bank Of America (BAC)

In the recent months, I have dialed back my stock buying due to a shift in my philosophy of stock investing. I have shifted from a speculator to an investor. The reason for the shift is simple, you make a hell of a lot more money being an investor than you do being a speculator. With this shift, I have begun to do some serious homework on my investment selections. I put a lot more effort into “turning over every stone” possible.

After my change of faith, I began looking at what I think is the best run bank in America. Bank of America (BAC). I already had a small position in them long before my change of philosophy but after I knew they were strong and I wanted to fully understand why. After finding the why, I increased my position, treating it as if I was buying the stock for the first time. Making this investment my first, in what I will now refer to as “The Investment Era”. I will walk you through the reasons why I chose to buy more and maybe you will see the same strength with this company as I have.

Size and Brand Strength

One of the first reasons why BAC sparked my interest was their pure size. Where I live, there is BAC’s everywhere. At one time in my younger years, I thought that everyone had an account with Bank of America. I don’t think I was far off. They are the 2nd largest bank ranked by size with 2.25 trillion in assets. Only behind J.P Morgan Chase (JPM) with 2.5 trillion in assets. To give you an idea, the 3rd largest bank is Wells Fargo (WFC) with 1.95 trillion. There is some distance between 2nd and 3rd. This size is a massive advantage. There are 4 total operating segments; consumer banking, global wealth and investment management, global banking, and the global markets segment. The addition of Merrill-Lynch in ’08 allowed BAC to create new revenue streams it did not have before. Each of the 4 operating segments is at the top of each of their respective industries. Here is a quick overview of each.

Related: Bank Of America Shareholders Presentation

Consumer Banking:

The largest profit turning segment. Bringing in 1.8 billion in net income. They are ranked #1 in deposit market share and deposits are up 41% from 2009. They are #1 in the U.S retail deposit market and #1 in 11 of the top 30 markets. They make about 100,000 transactions every 5 minutes. Since the financial crisis, they have been making changes for the benefit of the business. Like reducing the number of financial centers and decreasing costs. The average cost per deposit was $2.61 in 2009, in 2016 they are now at $1.71 per deposit. That is a 34% decrease in average cost per deposit since 2009.

Global Wealth and Investment Management:

The addition of Merrill-Lynch addition added the investment banking segment to BAC. Since the low point in 2009, ML has grown has its assets from $53 billion to $127 Billion, up 139%. This massive increase in assets has put BAC #1 in the wealth management market position across client assets, deposits, and loans. They were ranked #1 in Barron’s U.S. high net worth client assets (2015).  Barron also said they were one of the best online platforms for investment services.

Global Banking:

The global banking division is the second most profitable section of BAC bringing in $1.1 billion in net income in 2016. This segment is #1 globally ranked by volumes in leveraged loans, MBS, ABS, Investment grade corporate debt and syndicated loans. (I know that might read like jibberish to some of you, expected. Simply put, they are ranked #1 in the volume sections of transactions when it comes to offering loans, mortgage-backed securities, assets back securities, and investment grade corporate debt. They are #1 when it comes to up supplying loans smart loans) How do we know they are smart in the loan writing process? Well, the Net charge-offs (losing money on loans) has decreased 87% in the consumer segment and 92% in the commercial segment since 2010.  They are the best global transaction services and global loan house and BAC is the best bank for cash and liquidity management.

Global Markets:

This division of BAC brought in $1.0 billion in net income last year. They were rated the #1 research firm for the 5th consecutive year. 31 in global equities trading commission. Named Americas Derivatives house of the year.

One thing I liked to see when I was looking at the overall size and branding is their customer satisfaction rate. At the end of the day, it is the customers that will continue to drive the business. Since 2010 they have gone from 37.7% to 55% in the customer’s giving a 9 or 10 when asked about the overall satisfaction with BAC. At the end of the day, this is possibly the most important stat. One that should be taken into serious consideration.

Bank of America has the size and branding advantage over many other banks in the financial sectors. The 4 segments they operate are all at the top of the industry, supplying them with a healthy competitive advantage. But these are not the only reason why I liked them.

Financial Health

Another big reason why I loved BAC was that they have arguably the best financial health in the banking industry. There have been many changes since the crisis of 2008-2009 with that they have emerged stronger and more powerful. Some of these highlights will be discussed thoroughly.

First) A much stronger balance sheet:

Since 2009 they have made a smaller and safer balance sheet reducing their total assets 6% since ’09. I know that this might not seem like much but the true power lies in what they have done since 2009. Some of the highlights include: Since the fourth quarter of ’09  they have reduced their long-term by 55%, a massive reduction in illiquid assets going from 104B to 13B, and also increasing their cash and cash equivalents 45%.

Second) The most efficient bank

In the banking industry, they use what is called the efficiency ratio, this ratio simply tells us how efficiently the bank can create revenue. Consequently, the lower the ratio the better. For a long time, Wells Fargo was considered the most efficient bank until this year. Bank of America now sports an efficiency ratio of 59.5%. Simply put, it takes BAC $0.595 to create a dollar of revenue. This is much lower than the rising Wells Fargo number of 65.5 %. The industry benchmark is 60% if you are able to be around this number you are considered an efficient bank, BAC obviously exceeds that standard.

Third) Passing Stress Tests

In the wake of the financial crisis of ’09, we now have what is known as “stress tests” that keep big banks in check. It is a mathematical test for banks given different scenarios. These are sued to test what would happen if the bank ran into trouble. After doing the test, banks submit the results to the FED and they decide is the bank passes or fails the test. To pass the test a Bank needs to have minimum common equity tier 1 capital ratio of 8.2% (This is the ratio the FED uses to determine the pass or fail). In the most recent stress test, BAC had a CET1R of 12.1%. In addition to passing the stress test, BAC has the best loss rate in FRB stress tests of 4.6% the closest competitor to that is Wells Fargo with 5%.

Related: Stress Test Results

Fourth) A Better Credit Portfolio

I mentioned this briefly before, but it is a financial point that should be addressed again. Simply put, a bank is something that lends money out and charges interest rates based upon this the loan itself. When a loan cannot be repaid the bank loses money. That was what caused the housing crisis, too many risky loans were written they people could not pay back. It was more complicated than that but you get the picture. The thing that I really liked seeing was the Net Charge-offs have decreased rapidly since 2010 (Down 87% in the consumer segment and 92% in the commercial segment). It makes me trust them, knowing they are taking steps to make sure they don’t lose money.

Fifth) Running a Better More Profitable Business

At the end of the day, a good business can be qualified as one that increases revenues and profits on a consistent year over year basis. As per the latest third-quarter results, their net income is up 19% from 2016 even in the low-interest rate environment. There has been a steady trend of increases in net income over the past 5 years. Revenues have grown by increasing what they can control like growing loans and also be cutting management expenses.

Sixth and lastly) Still Positioned for Responsible Growth

Even though they cannot grow organically due to regulations they still have the ability to grow themselves on a responsible basis. The key word I like here is responsible Brian Moynihan wrote in the letter to shareholders a quote that shows the integrity he has in BAC, he said “Not every dollar is a good dollar unless it comes from activities that satisfy a customer need and fit our risk parameters.”. It is all about the responsible growth that is sustainable, so far they have shown us the growth they have already gone through was responsible and sustainable. As of right now they are well positioned for the future of the company. Some of the steps taken were reducing the noninterest expense by 28% and balancing their loan portfolio (it is now 49/51% consumer/commercial. Before it was 67/33% respectively), and they refocused their business on what works shedding more than $85B in non-core assets.

Altogether they are a financially healthy company it stood out to me when I first began researching them. Especially their stricter loan writing. It was addressed things got out of hand during the crisis. Many loans were written that could have been questioned by upper management, but now there is no messing around. The numbers show us that management is refocused and is no longer allowing greed to overcome them. Leaving money on the table is hard but it is clear that they want to grow in a responsible manner. Like Mr. Moynihan said, “not every dollar is a good dollar…”.  This shows their integrity and me as a shareholder, I want the integrity of management to be top notch. That will be discussed later on.

The financial strength of this company is another feather in its cap. The crisis proved to be a challenge for them. There was a bit of questioning but they are refocused now and the past is behind them. The stronger balance sheet can give any investor the safety of mind that even if there is an unfortunate event they will be able to get through the storm. The vicious stress tests have proved that they are now in a much better position financially than they were a few years ago and I see no changes to that anytime soon. Usually, once someone finds the right way for doing something they don’t go back to doing it the wrong way. The stress test results and the efficiency ratios can speak to enforce that. Right now they are better positioned for future sustainable growth. They have found a good place to be in that points upward for the company. I mean what more can you ask for in a company financially. They are lowering costs, controlling what they can control, increasing revenues, and growing profitability in a responsible sustainable manner. They have found what works and I do not see them backtracking and going back to what didn’t work. BAC is refocused and firing on all cylinders.

Leadership

Having a fast car is great. But having a fast car with a driver with no experience can be deadly. Someone with experience and is talented can optimize the performance of that car, They can probably do more with that car than you can expect. That is the key to the leadership of the companies you want to invest in. A leader and supporting staff that is reliable and can be behind the wheel of a fast car.

BAC’s leadership, in my opinion, is exceptional. Let’s first start with the big man at the top the CEO and Chairman of the Board, Brian Moynihan. He has been the CEO since 2010 but has been with BAC since 1993. Before becoming CEO of BAC he was the CEO of Merrill. Its safe to say he has experience in a leadership position, which is a good thing. He has nothing to prove to anyone that he is capable of this position. He is also regarded highly by his peers with a glass door review of 82% approval. To me seeing little things like this are what make the difference.

When I try to gauge the character of management it all begins with how they discuss company matters. Are they willing to admit failure or recognize the mistakes they have made? Or do they just believe they know what they are doing and can make no mistakes. A good leader will admit their wrongs without hesitation. The best place to see how a company operates is reading the annual reports along with the 10-k in the MD&A section.

After reading the letter to shareholders I could tell Brian was an excellent leader with a shareholder focus. The first line of the letter states how much capital they have returned to shareholders over the course of the year. To me, I love seeing a CEO make it a point to discuss the value that is being created for the shareholders. We are technically owners of the company so when the CEO is aware of that it is a great sign they are focused on the right objectives.

He makes it clear in the letter that there are two main objectives for BAC: 1) be the best bank. Period. 2) Return as much value to shareholders as possible. The latter I will discuss later. Right now I am going to point out the steps they are taking to be the best bank possible. It firsts starts with their commitment to sustainable growth, this is focused around four main tenets: 1) Grow and win in the market; no excuses 2) Grow within our customer-focused strategy 3) Grow within our Risk Framework and 4) Grow in a sustainable manner. Like I pointed out earlier, he has acknowledged that every dollar is not necessarily a good dollar unless it is earned through the activities that satisfy what they are trying to achieve. This speaks largely to the character of this man. I thoroughly enjoy it.

Brian is great on his own but one player can not win a championship. The board of directors is also top notch. 64% of the board has CEO experience, they know how to run a business. What I like seeing in my investments is that the management is experienced and successful. You don’t teach Lebron James how to play basketball. You wouldn’t teach this management how to run a business they have been successful before and because of their experience the momentum should carry them over not just years but decades.  This board has many jobs with a few of them approving the risk plans annually, approving growth plans, and shaping the long-term prospects by consistent communication with management. Everything an investor wants to see on a board of directors. When you build a team full of winners the outcome is easily predicted.

The management is what really impressed me and made the decision on investment that much easier. Knowing the leaders of this company are intelligent, full of integrity, and focused on the correct goals it makes me happy to be a shareholder.

Shareholder Focus

It was such a focus of the entire management and BAC as a whole that I thought it deserved an individual commentary. At the end of the day we, as shareholders, are all partial owners of the company. We want management to be focused on growing the business but also well aware of making sure the shareholders are happy. Making the shareholders happy and continuing to return the value is one of the main focusses of this company.

I will start first with the topic of past discussion, the board of directors. The BOD at BAC is made up of 93% independent directors. What does this mean? It means that other than sitting on the board the directors have no connection to the business. They are not tied to it from a management standpoint, just there to make sure the company is run well. Why is this good for us as shareholders? Having an independent board is a good thing because that means they have a shareholder like a mindset. With no ties to the company, they are strongly concerned with the results because they are in the same position we are, as shareholders. This type of focus and mindset will be rewarding for us as shareholders.

In the letter to shareholders, Brian Moynihan talked about how BAC is committed to capital returns. In the crisis of 2009 BAC issued more shares in the market to make them strong enough to continue since that point shares outstanding peaked at 11.6 billion. It is now the focus of management to buy back shares to reduce the shares outstanding to the appropriate levels they seek.  For shareholders, this is a good thing. Sometimes companies will have buybacks in times when their stock price is very high, at the levels BAC is at now I am okay with the buyback program.

They also have a strong and growing dividend. In 2016, the dividend was only 17% of earnings total. Since then, they have upped the dividend to a payout ratio of 19.7% of earnings. This level is good for a sustainable dividend. Over the years we should expect to see an increase in the dividend.

Seeing both of these factors I was pleased. When it comes to the share repurchases I am good with it considering the price level is respectable. With the dividend, I am pleased also. A low payout ratio is a nice sign, it is likely in the future that they will continue to up the dividend to continue to create shareholders value in the long term.

In Closing

It is for these reasons above that I love my recent addition of more BAC into my portfolio. You can tell when a special company comes along. it usually embodies three characteristics; strong financial health, strong demand, and great leadership. BAC has all three. I bought into the stock at levels in which I think are extremely below intrinsic value and plan to be a shareholder of BAC for a very long time. The two main focusses are being the best bank possible along with returning as much value back to shareholders as possible. There is not much more you could ask for as the owner of a business.

Peace and Love,
Michael


P.S. here if your friendly disclaimer. SISU Money has a disclaimer policy.

In full disclosure, I do own shares of Bank of America

4 thoughts on “Why I Bought More Bank Of America (BAC)

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