Analyst Calls Second Largest Bank Too Big To Manage, Instead Recommends 3rd Largest Bank

Its been a tough and confusing week for Bank of America shareholders. Let's cut through the confusion and clear all this up.

May 4, 2014 at 12:45PM

Here are some other headlines I considered for this article:

Analyst Says $2.1 Trillion Bank is Too Big To Manage, Needs to Downsize to $1.8 Trillion

Analyst Says Sell BAC Based on Miscalculation of 0.05%, Recommends More Careful Bank That's Failed Stress Tests 2 of 3 years

Analyst says B of A is Too Big To Manage, Instead Buy JPMorgan (Even Though JPMorgan is Much Bigger)

Analyst Calls B of A Too Big To Manage. Unless You're Jamie Dimon -- In Which Case It's Fine!

Analyst Recommends Selling B of A, But Leaves Press Conference Early to Go Have Lunch with Jamie Dimon

What am I talking about? Did you just check your browser to make sure your not on The Onion

Earlier this week, CLSA analyst Mark Mayo recommended that investors sell Bank of America (NYSE:BAC) and instead buy rival megabank Citigroup (NYSE:C).

Why? Because Bank of America is just too big to manage; the proof, he says, is in this week's announcement of an error in the bank's mark to market accounting that forced the bank to suspend its plan for a larger dividend and share buybacks. 

We have several moving parts in this story, so let's attack this one question at a time.

G

Question 1: Wait a second, Isn't Citigroup big too? Like, REALLY big? Pretty much the same size of Bank of America, big?

Answer: YES. Citigroup is HUGE.

Citigroup is 86% as large as Bank of America ($1.8 trillion to $2.1 trillion in total assets respectively). So apparently that last 14% of size is where big becomes too big?

Oh, and lest we forget, Citigroup has had its own share of regulator wrist slaps. In fact, Citi has failed its regulatory stress tests two out of three times. If that is any indication, then $1.8 trillion in assets is probably just as tough to manage as $2.1 trillion.

Dimon Quote Not All Companies Are

Analyst Mike Mayo, it seems, would agree.

Mayo even seems to get this, recently stating that even the great Jamie Dimon, CEO of the $2.4 trillion JPMorgan Chase (NYSE:JPM) couldn't manage Citi.

Wait...what?

JPMorgan, which is 15% bigger than Bank of America, can be managed fine, but the smaller Bank of America is too big to manage?

Unfortunately I don't have a good explanation for you on this one. If Bank of America is too big to manage, it stands to reason that Citi is also too big to manage. I'm just as confused as your are.

Question 2: OK, fine. He chose a bad example in Citigroup. But Bank of America DID mess up pretty bad, right?

Answer: Kind of.

Here's what happened. Bank of America acquired Merrill Lynch back in 2009. As part of that acquisition the bank came to possess some fancy loans called structured notes. The ones in question totaled about $60 billion.

$60 billion seems like a lot. But for Bank of America, it's really pretty insignificant. For Bank of America, $60 billion is just 2.8% of total assets. To put it in numbers we're all more familiar with, if you have $100,000 in total assets, then this is equivalent to $2,800. Not exactly a threat to the core of the business.

Where Bank of America messed up comes from the bank's failure to appropriately include short term changes in the values of these assets into the capital calculations used in the stress testing process.

The reality is that the impact of this mistake is hardly significant at all. The bank's capital ratio changed from 11.9% to 11.8%. That's right, a paltry 0.05%. Barely enough to cause the ratio to round down instead of up.

G

The Federal Reserve Bank in Chicago

The bank will not have to restate any earnings or refile any financials with the SEC. The issue is purely being driven by banking regulators who require banks to follow a different set of accounting rules surrounding marking these assets to market value.

Question 3: If this really isn't that big of a deal, then why have they suspended the dividend and buyback?

Answer: Because the regulators said so.

The thing about banking is that the regulators can more or less do whatever they want.

If the Fed says that Citigroup's stress tests are insufficient, then the stress tests are insufficient. End of story.

If the Fed says that Bank of America must resubmit its capital plan, then Bank of America must resubmit the capital plan. Period.

Its really just that simple.

However, that being said, there are a couple of very valid reasons for the Fed and Bank of America to take a prudent approach in this situation. First, there is the possible impact on the bank's capital in the severely adverse stress test. Matt Levine of Bloomberg.com addresses those issues quite well.

And second, any mistake large enough to warrant a press release like we saw this week calls into question Bank of America's internal controls and processes. I spoke with fellow Fool John Maxfield on this subject, and he told me,

The process itself is also a concern, as the Fed analyzes proposed capital actions with an eye to both quantitative and qualitative factors -- the qualitative factors being the efficacy of the process itself. Mistakes like this call the latter into question.

In essence: if they messed this up, what else could be wrong.

Question 4: How does all this shake out in the end?

Answer: Only time will tell, but most likely the Fed will approve a reduced dividend/buyback proposal

The financial impact of this miscalculation to Bank of America is largely irrelevant. The bank has been selling off these assets over time and showing any losses incurred on the books as the sales were realized. Whether the assets are marked to market is really a moot point-Bank of America's capital will take the hit either way. 

And again, don't forget that the size of this portfolio of assets is just 2.8% of Bank of America's total assets.

B Of A Sign

To me, the most likely scenario is that the Fed will review Bank of America's numbers again (probably with a finer toothed comb), and then approve a capital plan that is slightly scaled back from the original. I expect Bank of America and the Fed to move cautiously and with prudence. The public relations nightmare for both is bad enough as it is.  

Unfortunately for Bank of America, the general (and investing) public has become so accustomed to seeing negative headlines, that this situation was blown out of proportion. Over the long term, this event will be just another dot on the long timeline of Bank of America's public snafu's since 2006.

The core of the business though continues to improve. Brian Moynihan continues to lead the bank in the right direction. The bank's balance sheet continues its slow and steady healing process. Before long, Bank of America will once again be just another boring bank, making loans, taking deposits, and paying out a dividend. 

And to me, boring banks are the good banks.

Big banking's little $20.8 trillion secret
There's a brand-new company that's revolutionizing banking, and is poised to kill the hated traditional brick-and-mortar banks. That's bad for them, but great for investors. And amazingly, despite its rapid growth, this company is still flying under the radar of Wall Street. To learn about about this company, click here to access our new special free report.

Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers