DISSECTING A BANK S BALANCE SHEET

Transcription

1 DISSECTING A BANK S BALANCE SHEET March 14, 2013 Presented by: Bill O Neill, CFA 100 Federal Street, 33 rd Floor, Boston, MA (617)

2 BANK ANALYIS OVERVIEW Goal: Define a framework for critical analysis of bank debt Overarching Theme: Bank analysis is largely based on context Agenda: Hard to come to a conclusion on numbers alone; one should consider: Business model and organizational structure Economic environment (Fed, asset trends, liquidity, investor + counterparty behavior and perception) Regulatory environment and political climate Earnings power Funding stability Historical performance Performance vs. peers Bank universe overview + narrowing of scope Bank business model and organizational structure Income statement and Balance sheet overview Asset quality Liquidity & funding Bank capital Risk: Macro, regulatory and political & orderly liquidation authority Wrap-up 1

3 DOMESTIC BANK UNIVERSE Bank debt comprises ~17% of the investment grade credit universe 80/20 rule: 16 institutions comprise ~80% of the IG bank universe (64 tickers total) Further narrowing: BAC, JPM, C, and WFC, the Big Banks, represent ~40% of the bank universe GS and MS are often included in this group but differ substantially in business model and balance sheet composition Option Adjusted 1/31/13 Market Value ($bn) % of Index Spread (bp) Barclays Credit Index 4, % 127 % of Bank Universe Corporates 3, % 138 Financial Institutions 1, % 146 BANKING % % BANK OF AMERICA CORP % % JPMORGAN CHASE & CO % % GOLDMAN SACHS GROUP INC % % CITIGROUP INC % % MORGAN STANLEY % % WELLS FARGO & CO % % HSBC HOLDINGS PLC % % AMERICAN EXPRESS CO % % CREDIT SUISSE GROUP % % PNC FINANCIAL SERVICES GROUP % % UBS AG % % BANK OF NEW YORK MELLON CORP % % US BANCORP % % WESTPAC BANKING CORP % % BARCLAYS BANK PLC % % RABOBANK % % OTHERS % % Source: Barclays 2

4 UNIVERSAL BANK BUSINESS MODEL RETAIL BANK: Retail Banking Credit Card Services Consumer Real Estate Products Commercial & Industrial Loans / Leases ATTRIBUTES: Stable Balance Sheet Limited or Regional Customer Base Small $ Clients TRADITIONAL INVESTMENT BANK: Security Underwriting and Distribution Advisory (M&A) Commission Based Trading ATTRIBUTES: Intense Competition High Compensation Expense Low ROE Large $ Clients Highly Connected UNIVERSAL BANK: All of the aforementioned + Market Making (balance sheet supported trading) Client Solutions (FX, Currency, Commodity, & Rate Hedging) Prime Brokerage Principal Trading and Investing ATTRIBUTES: Higher ROA thus Higher ROE Increased Balance Sheet and Income Statement Volatility Economies of Scale High Barriers to Entry BUSINESS MODEL: Leverage large stable balance sheet to serve large clients via market making and financial solutions Economies of scale in retail banking Full service business 3

5 UNIVERSAL BANK ORGANIZATIONAL STRUCTURE Bank Operations: retail banking, credit card services, consumer and commerical lending Assets Credit Card and Loan Receivables Reverse Repo Agreements Liabilities Customer Deposits Bank Debt Repurchase Agreements Parent Holding Company Operations: liquidity & risk management Assets Cash Investment in Subs Liabilities Holding Co. Long Term Debt CP and Short Term Debt Equity Common and Preferred Equity Broker Dealer Operations: sales & trading, advisory & underwriting, wealth management, asset management, proprietary trading Assets Trading Account Assets Derivative Assets Proprietary Investments Reverse Repurchase Agreements Liabilities Trading Account Liabilities Derivative Liabilities Repurchase Agreements Other Operations: mortgages, fee business, insurance Assets Investment Securities Liabilities Customer Deposits Policy Account Balances Future Policy Benefits 4

6 INCOME STATEMENT OVERVIEW During the financial crisis market dislocations were a boon to banks capital markets operations Provisions escalated from losses on loans at the bank REVENUE DRIVERS Loan growth Capital markets activity Mortgage origination EARNINGS DRIVERS Loan losses Operating expenses Litigation expenses Compensation costs Big Four Consolidated Summary Income Statement Net Interest Income 115, , , ,399 Non-Interest Income 143,557 70, , ,225 Total Net Revenue 258, , , ,624 Provision for Loan Losses 17,222 97,457 86,021 29,619 Non-Interest Expense 146, , , ,260 Operating Income (Loss) 95,192 (33,506) 76,800 78,745 Net Non-Operating Losses 590 8,391 21,079 10,349 Pre-Tax Income (Loss) 94,602 (41,897) 55,721 68,396 Income Tax Expense (Benefit) 29,800 (20,230) 16,975 15,647 Net Income (Loss) 64,802 (21,667) 38,746 52,749 Source: Company Financial Statements as of 12/31/12 Big Four consist of Citigroup, JP Morgan, Wells Fargo, and Bank of America 5

7 INCOME STATEMENT OVERVIEW $bn Net Interest Income Big Four Total Revenue Non-Interest Income Average revenue split between interest income/ non-interest income has been about 50/ Top line growth has been driven by large bank mergers $bn Operating Income Big Four Operating Income and Provisions Provision for Loan Losses Provisions are a significant driver of earnings Source: Company Financial Statements as of 12/31/12. Big Four consist of Citigroup, JP Morgan, Wells Fargo, and Bank of America. 6

8 INCOME STATEMENT KEY METRICS % Big Four Net Interest Margin = Net Interest Income/ Avg. Earning Assets Median Net Interest Margin Low interest rates continue to pressure net interest income % Median ROE Big Four Return on Equity (ROE) Increased capital levels have depressed ROE relative to pre-crisis levels 12 8 In a heightened regulatory environment, is a mid-teen ROE achievable? Source: Company Financial Statements as of 12/31/12. Big Four consist of Citigroup, JP Morgan, Wells Fargo, and Bank of America. 7

9 BALANCE SHEET CAPITAL Simplified Bank Balance Sheet Assets Liabilities Consumer and commercial loans account for the majority of assets Banks estimate and reserve for potential future credit losses arising from their loan portfolio + Cash & cash equivalents + Short-term investments + Consumer loans: Residential mortgages Home equity Credit card Other + Commercial loans: Real estate Business loans Lease financing - Allowance for loan losses - Deposits: Savings and money market deposits Consumer CDs and IRAs - Repurchase agreements - Commercial paper - Long term debt Equity - Preferred stock - Common stock - Retained earnings Banks can fund lending operations through customer deposits and debt issuance However, during times of market distress, issuing debt may not be a viable option 8

10 KEY METRICS ASSET QUALITY Asset Quality Evaluation of loan portfolio Asset Quality Metric Purpose Loan Loss Provisions as % of Average Loans Nonperforming Assets as % of Loans Loan Loss Reserves as % of Nonperforming Assets Net Charge-offs as % of Average Loans Standardizes bank managements' estimate of the expected credit losses Standardizes the sum of nonaccrual loans + past due loans + restructured troubled debt LLR reflects bank managements estimate of future credit losses on its loans outstanding; ratio represents "Reserve Coverage" Standardizes the realization of default on specific loans held during the period, reduces reserves and assets Other Aspects of Asset Quality: Composition of loan portfolio Geography Loan type Security/recourse Delinquency trends % Big Four Nonperforming Assets and Loan Loss Reserves % Median Loan Loss Reserve % Nonperforming Assets (LHS) Median Nonperforming Assets % Loans (RHS) Source: Company Financial Statements as of 12/31/12. Big Four consist of Citigroup, JP Morgan, Wells Fargo, and Bank of America. 9

11 KEY METRICS LIQUIDITY + FUNDING Liquidity Ability to satisfy near-term obligations Ability to access capital markets Unrestricted liquid assets Liquid Assets Measured by high quality, liquid unencumbered securities Readily available to meet funding requirements Assets which qualify as liquid assets include: Cash US Government securities US Agency securities US Agency MBS Select group of non-us Government securities Funding Stability and efficiency of internal financing Dependence on wholesale funding Composition of capital structure 10

12 KEY METRICS LIQUIDITY + FUNDING % $bn 110 5,000 Total Deposits (RHS) 105 Median Loan / Deposits (LHS) 4, , Big Four Total Deposits and Loan to Deposits Banks have become less dependent on non-deposit funding due to strong deposit inflows and subdued loan growth 85 2, ,000 0 $bn Unsecured Debt Govt. Guaranteed Debt Net Issuance Big Four Total Debt Issuance Debt issuance has significantly declined as banks have decreased leverage Source: Company Financial Statements as of 12/31/12. Big Four consist of Citigroup, JP Morgan, Wells Fargo, and Bank of America. 11

13 BALANCE SHEET CAPITAL Bank Capital - Measure of a bank s ability to withstand losses Most basic definition is total assets minus total liabilities Represents the net worth of a bank or its value to investors Capital Term Definition Current US Regulatory Minimum (%) Basel III Regulatory Minimum (%)¹ Tier 1 Common Ratio Common equity + Retained earnings + Loan loss reserves² % risk weighted assets 5.0³ 7.0 Tier 1 Capital Ratio Tier 1 Common + non-cumulative preferred stock % risk weighted assets Total Capital Ratio Tier 1 + Cumulative preferred stock, subordinated debt and mandatory converts % risk weighted assets Leverage Ratio Tier 1 Capital % average assets excluding goodwill 3.0 N/A Risk Weighted Assets Sum of all on-balance sheet assets and credit equivalent amounts of offbalance sheet items, each weighted according to their credit risk category 1 Includes 2.5% capital conservation buffer which is required for max. payout of discretionary payments 2 Loan loss reserves are limited to 1.25% of risk weighted assets ³According to 2012 CCAR tests / was 2.0% Source: Federal Reserve 12

14 BALANCE SHEET CAPITAL Bank capital has increased post-crisis More conservative risk-adjusted balance sheets Regulation requires a higher base level of capital % 14 Big Four Tier 1 Common Ratio (Basel I) 12 Median Tier 1 Common Ratio Source: Company Financial Statements as of 12/31/12. Big Four consist of Citigroup, JP Morgan, Wells Fargo, and Bank of America. 13

15 RISK MACRO % Big Four Residential Loans % of Common Equity Residential Loans % of Common Equity BAC WFC JPM C Rising home prices should cure underwater loans and increase the propensity to lend % Big Four Peripheral Gross Exposure % of Common Equity Greece Ireland Italy Portugal Spain Exposure to European peripheral countries should be manageable relative to equity levels and has declined from a year ago BAC WFC JPM C Source: Company Financial Statements as of 12/31/12. Big Four consist of Citigroup, JP Morgan, Wells Fargo, and Bank of America. 14

16 RISK REGULATORY + POLITICAL : Laissez-faire Glass-Steagall repealed, business models forming, leverage growing, regulation light : Crisis US Govt. ensures ability to fund via alphabet soup Troubled Asset Relief Program (TARP CPP) Preferred Stock sold by SIFIs to US Treasury BAC $45bn, C $45bn, JPM $25bn, WFC $25bn Commercial Paper Funding Facility (CPFF) US Fed SPV that purchased $738bn in commercial paper from various financial and industrial issuers C $33bn, BAC $23bn Temporary Liquidity Guarantee Program (TLGP) FDIC guaranteed bank debt issued for a fee C $45bn, BAC $44bn, JPM $40bn, WFC $9bn Transaction Account Guarantee Program (TAG) FDIC insured unlimited customer deposits TSLF, AMLF, PPIP, TALF QE 1, 2, 3 + Twist 2010-Future: Stage Set For Removal of Systemic Importance Basel III + Dodd-Frank Basel III Higher capital requirements; quality of capital also to be improved Extra capital charge for large banks + countercyclical buffers (build capital in good times ) Standardized liquidity requirements (Liquidity Coverage Ratio) Source: Federal Reserve 15

17 RISK REGULATORY + POLITICAL Dodd-Frank Huge; 16 Provisions (Titles) Signed into law on 7/21/10; many of the particulars are still undefined All very important, but Titles I, II, and VI could directly change large bank business models Title VI Improvements to Bank Holding Company Act of 1956 (Volcker Rule) Reduces proprietary trading Good for bank balance sheets; not great for income statement or secondary market liquidity Five bodies working on specifics (Fed, FDIC, SEC, Treasury, OCC); ready by 2Q13 at the earliest Title I Financial Stability Act Establishes Financial Stability Oversight Council Large banks required to submit living wills Regulators must deem plans to be credible; Fed can take action if not Can impose higher capital requirements, asset sales, growth restrictions, liquidity restrictions Title II Orderly Liquidation Authority Eliminates tax-payer funded bail-outs for Systemically Important Financial Institutions Requires a bail-in framework Final scheme TBD but bail-in regimes only work if there is adequate holding co. capital to absorb losses Equity and debt Source: Federal Reserve 16

18 RISK TITLE II - ORDERLY LIQUIDATION AUTHORITY Single Entry Receivership Current Preferred OLA Approach Preferred method of resolution is using top of the house capital to absorb losses Investors must be aware of their location in the organizational structure and within the capital structure Holding Co. Enters Receivership Bridge Company Created Restructured Company Emerges Govt. provides liquidity facility Govt. facility becomes senior creditor Assets written down Losses are incurred from bottom-totop in the capital structure Govt. paid back loan Liabilities/equity restructured Holding Co. unsecured claimants likely receive a combination of debt and equity of new company Assets Liabilities Assets Assets Govt. Liabilities Assets Liabilities Equity Legacy Liabilities Equity 17

19 WRAP UP CRITICAL THINKING GAUNTLET What keeps the pulse going? Overarching Theme: Bank analysis is largely based on context Hard to come to a conclusion on numbers alone; one should consider: Business model and organizational structure Economic environment (Fed, asset trends, liquidity, investor + counterparty behavior and perception) Regulatory environment and political climate Earnings power Funding stability Historical performance Performance vs. peers 18

20 IR+M DISCLOSURE STATEMENT Disclosure Statement: The information contained in this report is based on information obtained by IR+M from sources that are believed to be reliable. This report is for informational purposes only and is not intended to provide specific advice, recommendations for, or projected returns for any particular IR+M product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from IR+M. This presentation was created for The Government Investment Officers Association. 19