1 Reason Bank of America Will Succeed

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Bank stocks aren't as complicated as many analysts on Wall Street would lead you to believe. My guess is that the analysts say they are simply to protect their own positions, however valueless they truly are. If everybody knew how to ply their trade, why would we pay a bunch of fancy-pants pencil pushers in New York City incongruous salaries to connect a handful of dots?

In fact, as my colleague John Reeves discussed here and here, this is the central thesis of a popular new book The Signal and the Noise, by Nate Silver, a polling guru who correctly predicted the outcome of the last presidential election in all 50 states. The trick, according to Silver, is to distinguish between the "signal," which he defines as the "truth," and the "noise," which "distracts us from the truth."

How does this apply to banks, you ask? Simple. The fundamental business model of more than 99% of all lenders is to do one thing: arbitrage interest rates. That is, they borrow funds at low interest rates and then lend those same funds back out at higher rates. The name of the game is maximize the spread between these rates without making too many bad loans in the process.

That's it. You may now consider yourself a bona fide bank analyst.

What this means for Bank of America
It's for this reason, among others, that I believe Bank of America (NYSE: BAC  ) will successfully dig its way out of the hole it's been in for the past five years. Consider this:

Source: FDIC's Top 50 Bank Holding Companies by Total Domestic Deposits.

B of A is far and away the nation's largest deposit holder, handily beating out its closest competitors in this regard, including Wells Fargo (NYSE: WFC  ) , JPMorgan Chase (NYSE: JPM  ) , Citigroup (NYSE: C  ) , and Capital One (NYSE: COF  ) . According to data from the FDIC, in fact, B of A alone holds roughly 12% of the entire nation's deposits.

This matters because deposits are far and away the cheapest source of funds available to banks -- or any other type of financial institution, for that matter.

And now, consider this as well:

Source: Bank of America's 3Q12 10-Q, pages 26 and 28.

B of A's reliance on deposits couldn't be more convenient, as they cost a fraction of the amount that other funding sources do. For instance, while B of A must pay 3.07% on its nearly $300 billion in long-term loans, it need pay only 0.28% on the nearly $700 billion in interest-bearing deposits. And to top things off, it needn't pay a single cent on over $360 billion in funding from non-interest-bearing deposits, like those amounts sitting in its customers' checking accounts.

Once all of the different sources are combined into a weighted average, B of A's total funding cost comes out to 1.16%. That's roughly only a third of its 3.22% yield on average earnings assets. And there you have it. Assuming B of A can continue to rid its balance sheet of the toxic assets that are currently dragging it down, this spread will fuel positive returns for shareholders for many years to come.

Want to learn more about Bank of America?
I've made no secret that I'm bullish on B of A. But I'm not the only one. In a new in-depth report on the bank, our senior banking analyst, Anand Chokkavelu, explains why he believes its stock could "double or triple over the next five years." To see why Anand thinks this is so, download a copy of his report instantly by clicking here now.

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  • Report this Comment On December 02, 2012, at 7:20 AM, jgetze wrote:

    Great piece, although I wonder if simple truth really flies in this world anymore.

    The only other fundamental I might have added: B of A and other lenders leverage their deposits by making loans.

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