Sunday, November 4, 2007

Stock Analysis: Bank of America (BAC)

Company Description:

Bank of America Corporation (Bank of America), incorporated in 1998, is a bank holding company. Through its banking subsidiaries and various non-banking subsidiaries throughout the United States and in selected international markets, Bank of America provides a diversified range of banking and non-banking financial services and products through three business segments: Global Consumer and Small Business Banking, Global Corporate and Investment Banking, and Global Wealth and Investment Management. The Company operates in 30 states, the District of Columbia and 44 foreign countries. In the United States, it serves more than 55 million consumer and small business relationships with more than 5,700 retail banking offices, more than 17,000 automated teller machines (ATMs) and more than 21 million active online users. It offers services in 16 states.

Click here for a full description of the company’s operations (provided by Reuters).

Annual Report Highlights (latest report is for the period ending 12/31/06):


General


The Bank of America footprint covers more than 75 percent of the U.S. population and 44 percent of the country’s wealthy households. In the United States, we serve more than 55 million consumer and small business relationships with more than 5,700 retail banking offices, more than 17,000 ATMs and more than 21 million active on-line users. We offer services in 16 of the 20 fastest growing states. Bank of America is the number one small business bank, and has relationships with 98 percent of the U.S. Fortune 500 Companies and 80 percent of the Global Fortune 500 Companies.


The methods of competition center around various factors, such as customer service, interest rates on loans and deposits, quality and range of products, lending limits and customer convenience, such as locations of offices.


Employees


As of December 31, 2006, there were 203,425 full-time employees within Bank of America and our subsidiaries. Of these employees, 100,909 were employed within Global Consumer and Small Business Banking, 26,622 were employed within Global Corporate and Investment Banking and 13,728 were employed within Global Wealth and Investment Management . The remainder were employed elsewhere within our company including various staff and support functions.


Risk Factors

  • General business, economic and political conditions.
  • Access to funds from subsidiaries.
  • Changes in accounting standards
  • Competition.
  • Credit risk.
  • Federal and state regulation.
  • Governmental fiscal and monetary policy.
  • Liquidity risk.
  • Litigation risks.
  • Market risk.
  • Merger risks.
  • Non-U.S. operations; trading in non-U.S. securities.
  • Operational risks.
  • Our reputation is important.
  • Products and services.
  • Risk management processes and strategies.
  • We operate many different businesses.
Properties

As of December 31, 2006, Bank of America’s principal offices and primarily all of our business segments were located in the 60-story Bank of America Corporate Center in Charlotte, North Carolina, which is owned by one of our subsidiaries. We occupy approximately 637,000 square feet and lease approximately 547,000 square feet to third parties at market rates, which represents substantially all of the space in this facility. We occupy approximately 926,000 square feet of space at 100 Federal Street in Boston, which is the headquarters for one of our primary business segments, the Global Wealth and Investment Management Group. The 37-story building is owned by one of our subsidiaries which also leases approximately 463,000 square feet to third parties. We also lease or own a significant amount of space worldwide. As of December 31, 2006, Bank of America and our subsidiaries owned or leased approximately 25,500 locations in 38 states, the District of Columbia and 28 foreign countries.


Management’s Discussion and Analysis of Financial Condition and Results of Operations

Recent Events


In December 2006, the Corporation completed the sale of its retail and commercial business in Hong Kong and Macau (Asia Commercial Banking business) to China Construction Bank (CCB) for $1.25 billion. The sale resulted in a $165 million gain (pre-tax) that was recorded in Other Income.


In November 2006, the Corporation announced a definitive agreement to acquire U.S. Trust Corporation (U.S. Trust) for $3.3 billion in cash. U.S. Trust is one of the largest and most respected U.S. firms which focuses exclusively on managing wealth for high net-worth and ultra high net-worth individuals and families. The acquisition will significantly increase the size and capabilities of the Corporation’s wealth business and position it as one of the largest financial services companies managing private wealth in the U.S. The transaction is expected to close in the third quarter of 2007.


In September 2006, the Corporation completed the sale of its Brazilian operations in exchange for approximately $1.9 billion in equity of Banco Itaú Holding Financeira S.A. (Banco Itaú), Brazil’s second largest nongovernment-owned banking company. The sale resulted in a $720 million gain (pre-tax) that was recorded in Other Income. In August 2006, we announced a definitive agreement to sell our operations in Chile and Uruguay for stock in Banco Itaú and other consideration totaling approximately $615 million. These transactions, as well as the previously announced sale of our operations in Argentina, are expected to close in early 2007.


MBNA Merger Overview


The Corporation acquired 100 percent of the outstanding stock of MBNA Corporation (MBNA) on January 1, 2006, for $34.6 billion. The acquisition expands the Corporation’s customer base and its opportunity to deepen customer relationships across the full breadth of the Corporation by delivering innovative deposit, lending and investment products and services to MBNA’s customer base. Additionally, the acquisition allows the Corporation to significantly increase its affinity relationships through MBNA’s credit card operations and sell these credit cards through our delivery channels (including the retail branch network). MBNA’s results of operations were included in the Corporation’s results beginning January 1, 2006.

Performance Overview

Net Income reached $21.1 billion, or $4.59 per diluted common share in 2006, increases of 28 percent and 14 percent from $16.5 billion, or $4.04 per diluted common share in 2005.


Global Consumer and Small Business Banking


Net Income increased $4.2 billion, or 59 percent, to $11.2 billion and Total Revenue increased $13.4 billion, or 47 percent, to $41.7 billion in 2006 compared to 2005. These increases were driven by higher Net Interest Income and Noninterest Income.


Net Interest Income increased primarily due to the MBNA merger and organic growth which increased Average Loans and Leases. Noninterest Income increased primarily due to the MBNA merger which resulted in an increase in Card Income driven by increases in excess servicing income, cash advance fees, interchange income and late fees. These increases were partially offset by higher Noninterest Expense and Provision for Credit Losses, primarily driven by the addition of MBNA.


Global Corporate and Investment Banking


Net Income increased $408 million, or six percent, to $6.8 billion in 2006 compared to 2005. Total Revenue increased $2.1 billion, or 10 percent, to $22.7 billion in 2006 compared to 2005, driven primarily by higher Trading Account Profits and Investment Banking Income, and gains on the sales of our Brazilian operations and Asia Commercial Banking business. Offsetting these increases was spread compression in the loan portfolios which adversely impacted Net Interest Income. In addition, Net Income in 2006 was impacted by increases in Noninterest Expense and Provision for Credit Losses, and a decrease in Gains on Sales of Debt Securities.


Global Wealth and Investment Management


Net Income increased $87 million, or four percent, to $2.4 billion in 2006 compared to 2005. The increase was due to higher Total Revenue of $463 million, or six percent, primarily as a result of an increase in Investment and Brokerage Services partially offset by an increase in Noninterest Expense of $295 million, or eight percent, driven by higher personnel-related costs.


Total assets under management increased $60.6 billion to $542.9 billion at December 31, 2006 compared to December 31, 2005.


Financial Highlights


Net Interest Income


Net Interest Income on a FTE basis increased $4.2 billion to $35.8 billion in 2006 compared to 2005. The primary drivers of the increase were the impact of the MBNA merger (volumes and spreads), consumer and commercial loan growth, and increases in the benefits from asset and liability management (ALM) activities including higher portfolio balances (primarily residential mortgages) and the impact of changes in spreads across all product categories. These increases were partially offset by a lower contribution from market-based earning assets and the higher costs associated with higher levels of wholesale funding. The net interest yield on a FTE basis decreased two basis points (bps) to 2.82 percent in 2006 due primarily to an increase in lower yielding market-based earning assets and loan spreads that continued to tighten due to the flat to inverted yield curve. These decreases were partially offset by widening of spreads on core deposits.


Noninterest Income


Noninterest Income increased $13.1 billion to $38.4 billion in 2006 compared to 2005, due primarily to the following:
  • Card Income increased $8.5 billion primarily due to the addition of MBNA resulting in higher excess servicing income, cash advance fees, interchange income and late fees.
  • Service Charges grew $520 million due to increased non-sufficient funds fees and overdraft charges, account service charges, and ATM fees resulting from new account growth and increased account usage.
  • Investment and Brokerage Services increased $272 million primarily reflecting higher levels of assets under management.
  • Investment Banking Income increased $461 million due to higher market activity and continued strength in debt underwriting.
  • Equity Investment Gains increased $977 million primarily due to favorable market conditions driven by liquidity in the capital markets as well as a $341 million gain recorded on the liquidation of a strategic European investment.
  • Trading Account Profits increased $1.4 billion due to a favorable market environment, and benefits from previous investments in personnel and trading infrastructure.
  • Mortgage Banking Income decreased $264 million primarily due to weaker production income driven by margin compression, which negatively impacted the pricing of loans, and a decision to retain a larger portion of mortgage production.
  • Other Income increased $1.2 billion primarily related to the $720 million (pre-tax) gain on the sale of our Brazilian operations and the $165 million (pre-tax) gain on the sale of our Asia Commercial Banking business.
Dividends

Effective for the third quarter 2006 dividend, the Board increased the quarterly cash dividend 12 percent from $0.50 to $0.56 per share. In October 2006, the Board declared a fourth quarter cash dividend of $0.56 which was paid on December 22, 2006 to common shareholders of record on December 1, 2006. In January 2007, the Board declared a quarterly cash dividend of $0.56 per common share payable on March 23, 2007 to shareholders of record on March 2, 2007.


Common Share Repurchases

We repurchased approximately 291.1 million shares of common stock in 2006 which more than offset the 118.4 million shares issued under employee stock plans.

In April 2006, the Board authorized a stock repurchase program of up to 200 million shares of the Corporation’s common stock at an aggregate cost not to exceed $12.0 billion to be completed within a period of 12 to 18 months of which the lesser of approximately $4.9 billion, or 63.1 million shares, remains available for repurchase under the program at December 31, 2006.


In January 2007, the Board authorized a stock repurchase program of an additional 200 million shares of the Corporation’s common stock at an aggregate cost not to exceed $14.0 billion to be completed within a period of 12 to 18 months. A total of $18.9 billion is available for common stock repurchases during 2007.

Financial Highlights:

Revenue Growth (1-yr): 30.2%
Revenue Growth (10-yr average): 22.0%

Net Income Growth (1-yr): 28.4%
Net Income Growth (9-yr average): 26.1%

Earnings-Per-Share Growth (1-yr): 13.6%
Earnings-Per-Share (10-yr average): 8.9%

Net Profit Margin (current): 29.0%
Net Profit Margin (5-yr average): 25.7%

Return On Equity (current): 16.3%
Return On Equity (5-yr average): 18.9%

Valuation:

Given that this is a financial services firm, it’s impossible to use a discounted cash flow analysis I typically rely on in my valuation of stocks. Therefore, I have to largely rely on Morningstar’s valuation, my assessment of the financial information that is available to me, and looking at comparative P/E ratios. So here are the results that I have from this ad-hoc assortment of resources:

  • Morningstar believes this company trades at a more than 30% discount to its intrinsic value. By substituting free cash flow for net income in the DCF model, my valuation would be even higher, at around $80/share. Assumptions that I used in such a model were 6% annual net income growth for the next ten years, perpetual growth of 3%, and a discount rate of 10.5% (since this company is average risk).
  • Trailing P/E of 9.4 is at a 20% discount to the 5-yr average P/E of 11.8.
  • B of A has posted very impressive revenue and net income growth rates during the past decade. Although it’s questionable how it will perform in the short-term, it’s unlikely that anyone doubts it’s long-term viability and future growth prospects.

Pros:

  • Company seems to be in a better position amid the credit market meltdown than some of its competitors, namely Citigroup, which has over $100 billion in SIVs that are highly exposed to the current risky market conditions.
  • It has the largest share of the domestic deposit market: 9.9%.
  • Company still hasn’t materialized all of its cross-selling potential among customers of its different business: only 10% of its high net-worth retail customers use its private banking services.
  • B of A is a fairly aggressively buying back its common shares, which consistently boosts earnings per share.
  • Company offers a very attractive dividend currently yielding 5.10%.
Cons:
  • Company’s high-growth vehicle, investment banking, isn’t expected to grow much given the slowdown in the private equity markets.
  • Flat yield curve diminishes company’s earning potential in this market.
  • Company’s acquisition potential is somewhat diminished by the fact that it reached it’s limit in U.S. deposits allowed by law (10%) and cannot purchase any domestic depository banks.
  • B of A’s impressive growth rates in recent years aren’t likely to sustain themselves as growth will be depressed because of the tight credit market conditions and general economic slowdown.
Final Decision:

Bank of America is a long-term “buy” in my book. Unless I come across a better large-cap financial stock, it might get replaced, but that isn’t likely to happen. B of A seems to be a better bet than its competitors such as Citigroup, J.P. Morgan Chase, and Wells Fargo, because of the stronger balance sheet and better growth prospects. It seems to be, that this is one of those times when a solid wide-moat company is available at a discount price because of short-term problems, while its long-term earning potential hasn’t changed. So, I’m adding Bank of America to my list of finalists that currently also includes: Johnson & Johnson (JNJ), Medtronic (MDT), and possibly Capital One Financial (COF).

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