Last month, Bank of America (BoA) released its preliminary full year results for FY2019. The Bank reported a net profit (after cash preferred dividends) of $26.0 billion for FY2019, a decrease of 2.6 per cent over FY2018 (net profit: $26.7 billion). Nonetheless, it still managed to improve its earnings per share (EPS) to $2.75, an improvement of 5.6 per cent over FY2018 (EPS: $2.61). This is due to the shares repurchase program of the Bank, where during the 2019 BOA repurchased $28.1 billion shares.
Net interest income (NII)
Despite the Fed’s rate cuts during 2019, the Bank’s NII increased by 3.1 per cent year-on-year (yoy). This was mainly characterised by a growth in the Bank’s loan book, which grew by 3.7 per cent yoy. The fact that the Fed’s rate cuts occurred during the second half of 2019 lessened the impact on the Bank’s performance for FY2019. Nonetheless, the Bank expects the October 2019 Fed rate cut to be more reflective in Q1 2020, thus implying a lower expected yield for this quarter. Additionally during Q1 2020, BoA’s management expects reinvestment rates to dilute securities yield, despite fractionally higher long-end rates.
On a positive note, the Bank anticipates solid growth in consumer loans, assuming the current economic environment, as well as the pull-through of mortgage applications through the pipeline. BoA expects that it can start growing card balances over time. With respect to residential mortgages, applications were strong in Q4 2019 and that should translate to solid Q1 2020 growth. The Bank expects loans to be up modestly yoy and it looks for solid growth in small business. The outlook for commercial loans remains favourable.
Non-interest income
Trading account profit increased by 5.1 per cent yoy, which is reflective of the superb market performance registered during 2019. This positive performance in trading profit has also been witnessed in local banks. Commissions and fees earned remained largely flat when compared to last year, except for a marginal decrease of 0.9 per cent. Other operating income decreased by $1.7 billion in FY2019, resulting in non-interest income to drop by 3.4 per cent yoy.
Non-interest expenses
In FY2019, expenses increased by 3.8 per cent and this was mainly as a result of a one-off, impairment charge of $2.1 billion relating to the notice of termination of the merchant services joint venture. If excluded expenses would have marginally decreased on a comparative basis, resulting in a cost efficiency ratio of 57.6 per cent (reported 59.6 per cent), FY2018 cost efficiency ratio of 57.4 per cent.
The Bank’s expectations on expenses for FY2020 haven't changed since FY2016 despite all the added costs of the higher investments and unknowns like Brexit. The Bank expects its full year expenses to be in the low $53 billion range in FY2020, and as long as client activity and the economic environment remain stable, its investment plans will likely remain unchanged.
Taxation
BoA’s effective taxation for FY2019 was of 16.3 per cent (FY2018: 18.6 per cent). This was lower for two main reasons; higher tax credits as a result of an increase in tax advantage investments and a number of discrete benefits from the resolution of several one-off tax matters. Management expects the effective tax rate for FY2020 to be in the region of 18 per cent.
Technology investments
The Bank spent $3 billion on innovation technology in FY2018, $3.3 billion in FY2019 and is scheduled to keep technology innovation investments unchanged in FY2020.
Capital target
The Bank continues to target a CET1 of 10 per cent (11.2 per cent in Q4 2019). BoA expects to increase its dividend payout to circa 30 per cent and use the remainder for share repurchases.
Following the financial crisis of 2008-09, it was decided that banks should have their own capital buffers to absorb any losses. This led to the setting up of an international regulator, the Financial Stability Board (FSB). Subsequently, the FSB created the TLAC ratio (Total Loss-Absorbing Capacity). The buffer, comprising capital and similar instruments, would represent 16 per cent of their total risk-weighted assets. The TLAC ratio must be implemented between 1 January 2019 at the earliest and 2022 by the world’s 30 banks considered as global systemically important banks, including BoA. In 2022, this capital buffer will be raised to 18 per cent.
Our concern is that the Bank’s capital ratio is below the target TLAC ratio and additional share repurchases/dividends will continue depleting its capital base.
Financial performance
US banks’ financial performance continues to outperform their European counterparts. Major US banks are currently generating a ROE of 11.2 per cent, with the largest European banks currently averaging a ROE of 7.1 per cent. This indicates why US Banks are being priced at 1.21x of the book value, with European peers trading at 0.74x of the book value. BoA is currently trading at 1.23x of the book value, in line with the US banks benchmark.
European banks continue to face punishingly low interest rates and stringent capital requirements, with a hazy outlook for the European housing market. This is contrary to the US economy, where the current Fed Funds Rate is 1.75 per cent, higher than the current ECB’s main refinancing rate of -0.5 per cent. US Banks also benefit from less harsh capital requirements, with the average Tier 1 Ratio of US Banks and European Banks standing at 14.9 per cent and 15.9 per cent, respectively.
Disclaimer: This article was issued by Rowen Bonello, research analyst at Calamatta Cuschieri. For more information visit www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.