This article is part of a series on the complete valuation analysis of Bank of America (NYSE: BAC). For Jordan's full analysis, click here.
Name the number one investment bank.
The bank that everyone loves to hate is on the mend, and part of its investment banking arm, through its Global Banking unit, is performing spectacularly.
What Global Banking does best
Global Banking is best described as a commercial and corporate banking unit. It's here that Bank of America stashes most of its investment banking advisory fees, a portion of its debt and equity underwriting fees, and fees and interest income from a more traditional corporate and commercial bank.
When I think about Global Banking, I think about two discrete units. The first is the commercial banking portion, which works with smaller, middle-market businesses. Then there's the investment and corporate bank, which works with the world's largest companies, governments, and institutions.
A hedged business
Bank of America's Global Banking unit has performed well as low rates encourage corporate borrowing, boosting investment banking fees and loan growth. On the other hand, lower rates aren't good for the loan book, which has seen its net interest spread shrink by 0.5 percentage points, from 3.18% to 2.68% in the first quarter of 2014. A recent company presentation calls for $8.8 trillion in global debt issuance in 2014, down from a peak of $9.5 trillion in 2013.
Moreover, the bank is crimped by new regulatory oversight. In the middle market, for instance, regulators have imposed a soft limit of 6 times EBITDA leverage for buyout deals. That could soften demand for cheap leverage from Bank of America's corporate bank.
The good news, though, is that higher rates will lead to rising net interest income. Loans and leases are priced on LIBOR, thus an increase in interest rates may stymie the growth in debt underwriting fees, but propel earnings from the loan book.
Credit trends are improving. In the first quarter, nonperforming loans and foreclosures fell to 0.24% of assets, down from 0.66% in the first quarter of 2013.
Valuing Global Banking
Is the economy in the top of the third inning, or the bottom of the ninth? That's the real question for any cyclical business. And while I could pretend to know what the economy will bring three or four years down the line, I certainly don't know.
But that doesn't make the bank impossible to value. Rather, it means we have to be conservative and build in a margin of safety.
For a bank that generated greater than 20% returns on allocated capital in 2013, a multiple of 1.5 times allocated capital makes sense to me, given that cyclical, and largely unpredictable, investment banking revenue makes up roughly 20% of net revenue.
That would give Global Banking a valuation of $46.5 billion, less than ten times net income in 2013, and well in-line with its peers.
Upside comes in the form of an improved expense line. Bank of America has proudly ditched its least-valuable clients, slashing its client list by 55% since 2010. And although that may seem like a grave mistake, average revenue per client has doubled in that time. Becoming leaner has resulted in better profitability, for which shareholders should be very pleased.
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For Jordan's full Bank of America analysis and total valuation number, click here.