Monday, April 28, 2014

Bank of America’s Real Surprises

Roy C. Smith

An accounting mistake reveals how questionable bank financial reporting has come to be, and how weak two of our largest banks still are.

Earlier today Bank of America announced that, due to a material accounting error going back to 2009, it was cancelling its long sought four cents per share quarterly dividend increase and $4 billion stock buyback plan. The Federal Reserve only recently approved this payout plan after its 2013 Comprehensive Capital Analysis and Review (CCAR) of Bank of America’s capital position.
The event calls attention to the extraordinary complexity of bank financial reporting and its dubious value for important regulatory or investment purposes.  Always voluminous, Bank of America’s annual report had 141 pages of financial statements in 2007, and but 257 in 2013, reflecting new disclosures imposed since the crisis.  So much data is bound to contain errors or need correcting from time to time. In any event, it is more than even skilled investment analysts or regulators can process
The event may also be an additional argument for why the Fed should emphasize “qualitative considerations” in assessing a bank’s overall financial position, as it did in its recent rejection of Citigroup’s plan to return capital to its shareholders after meeting the quantitative requirements of its CCAR.
But it also reminds us that both Bank of America and Citigroup continue to be economic basket cases, six years after the crisis. Without government assistance, (since repaid) both banks would have failed.  But neither bank is out of the woods, even now.
Bank of America recently reported another quarterly loss, its fourth such since 2010. Both it and Citigroup reported returns on equity for the first quarter of 2014 approximately 13% less than their costs of equity capital, and both of their shares trade at 72% of book value despite a significant rise over the last 2 years. 
Both banks have failed to cover their cost of capital, and have traded well below book value, for the last 21 quarters.
Both have bond ratings from Moody’s of Baa2, lower than all of their peers.
Both banks also pale in comparison to their biggest national banking competitor, Wells Fargo, the most valuable financial services firm in the US with a market capitalization of $260 billion. Wells Fargo reported a return on equity 4.65% greater than its cost of equity capital for the 1Q2014 period, and trades at 1.6 times book value.  Its dividend and stock buyback payout ratio is 55%, compared to 1% for both Bank of America (after the announcement) and Citigroup. 
Wells Fargo is not hampered by an extensive and difficult to manage commitment to trading and investment banking. Citicorp’s acquisition by Travelers in 1998 put it into these businesses (through Salomon Bros., previously acquired by Travelers), and Bank of America acquired Merrill Lynch in 2008, along with the endlessly toxic Countrywide Financial.
It may be that neither Bank of America nor Citi will be able to get back to “normal” until they shed (or greatly diminish) their investment banking businesses and refocus themselves on a consumer and commercial banking business model more like Wells Fargo’s.

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