In September, Bank of America chairman and chief executive Brian Moynihan presented to investors at the bank’s own financial services conference in London some of the key lessons learned 10 years on from the start of the global financial crisis.
His most important is to run the bank so that it cannot be disrupted by a change of heart on it by any third party, such as a rating agency or even a group of investors, equity income funds worrying about a cut in dividends, for example.
Moynihan offers a reminder of the resilience of a bank now sitting on $514 billion of liquidity – double what it had before he took over as chief executive at the start of 2010 – that could now keep running for 49 months through a crisis without having to raise a single cent in market funding.
It has taken short-term commercial paper outstandings down from $35 billion to zero; long term debt is down from $523 billion to $224 billion and would be $100 billion lower were it not for the need to maintain bail-in-able debt to comply with Total Loss Absorbency Capacity regulations.
This is a bank funded by deposits that makes loans, often secured such as mortgages, to customers whose solvency it has clear sight on as their main provider of financial services, and that it holds as assets on its balance sheet. It has gone back to the future.
Euromoney is intrigued that Moynihan should start with the bank’s resilience at the webcast presentation and later asks to follow up.
We are now well into an interest rate rising cycle in the US. Morgan Stanley, for example, now believes the Fed will hike four more times – 25 basis points (bp) each – before the end of 2018 for a cumulative 200bp rise in policy rates since the end of 2015. We have heard for years that this will be a boon to banks. Bank of America is delivering $5 billion in profit per quarter and has said that an instant parallel 100bp rise in rates across the curve would increase its net interest income by $3.2 billion in the following 12 months.
But when Euromoney talks to Moynihan we want to know about the downside of interest rate rises and the bank’s ability to cope with borrowers struggling to stay current on loan servicing.
Moynihan says that one of the best things to come out of the crisis has been enhanced stress testing and how it is incorporated into the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR). The Fed this year approved the bank’s plans to pass $17 billion of capital back to shareholders in dividends and share repurchases over the next 12 months and the Fed’s data showed that in a severe downturn Bank of America might suffer 4.6% of loan losses across nine quarters: the lowest of the big four American banks.
|Responsible loan growth reduces risk|
|Cumulative 9-quarter loss rate in FRB stress test (%)|
|Source: Bank of America|
“If you look at credit cards, as one example, where pre-crisis this bank was more focused on product sales than our current focus on deeper relationships, we tended to issue new cards to as many customers as possible and we used to charge off close to 5% a year even in the good times,” says Moynihan. “We ran up $154 billion in balances and ended up writing off $50 billion of that over the next few years.”
Since 2010 the bank has focused on being a low-cost provider to consumers across the board, and for prime customers, aims to be their main checking account and card provider. “We don’t pay staff incentives based on unit sales. Our aim is to be the customers’ overall relationship bank,” says Moynihan.
Bank of America’s last earnings announcement showed this starting to pay off for shareholders through positive operating leverage with the consumer bank growing revenues by 7% and cutting costs by 2% and looking like a model of efficient management.
Half of the bank’s close to $1.3 trillion in deposits come from consumers using Bank of America for their main checking account, which requires maintaining positive balances in return for low cost access to a range of familiar and new digital services.
Moynihan mentions just one. Losing your credit card is a pain. Bank of America can quickly load a card into the mobile wallet on a customer’s smart phone, so that they can resume paying for things even while they wait for their new plastic. That kind of service removes incentive to shop around for higher rates. These are interest free and dependable balances that have risen in volume even as the number of checking accounts has fallen as the bank targets customers more discerningly.
But is this just market beta? Will it still look good when the credit cycle turns?
The CCAR results looks like validation, but they are a modelling outcome. Real economic downturns and financial crises never turn out as the models predict. Can investors put faith in them?
“Yes, it is regression modelling, but the modelling has improved over many years of doing these stress tests and, just as important, the quality of data going into the models is much better,” Moynihan tells Euromoney.
“I’ll give you an example. When the oil industry was hit and the price fell from over $100 in mid 2014 to $35 by the end of 2015, we were able to manage our exposure to the industry very well so that we are also able to resume lending very quickly after the uncertainty passed. But more than that we were also able to focus on consumer customers living in the zip codes worst affected by the oil price collapse and monitor for changing behaviour that might indicate stress even before customers actually got into trouble and needed our help.
“We manage to a clearly articulated risk appetite and act as the core bank to good quality customers looking for a deeper relationship. That means growth may sometimes look slower than certain investors would like. But it’s responsible growth that is sustainable to support customers over time. Another lesson of the crisis was that if you grow too fast, when problems emerge lending comes to a sudden dead stop. That’s not good for anyone. In the next economic downturn, this bank will be able to keep supporting the economy.”
We’ll see, possibly sooner than bank equity investors appear to think.