The new number one -Bank of America
Bank of America takes number one position in FI profitiability, and almost number one in market cap.
Jul 27th 2006 | CHARLOTTE
From The Economist print edition
SENIOR employees of Bank of America (BofA) packed into the auditorium at the company’s headquarters in Charlotte on July 20th. They had gathered to hear Kenneth Lewis, the chief executive, deliver a long-awaited message: thanks to BofA’s earnings of $5.5 billion in the second quarter, they now worked for the most profitable financial institution in the world. To cheers, he added: “It was nothing personal; Citi just got in the way.”
“Citi”, of course, is Citigroup. For BofA, passing Citigroup’s profit number is a joy to be topped only when it has the greatest stockmarket value, too. A year ago that would have been laughable: the gap exceeded $40 billion. Today it is merely $4 billion (see chart).
Mr Lewis could always take the top spot by promising never to make another dilutive acquisition. He won’t, but BofA may reach the summit anyway. Citigroup, it is true, has more revenue. It also has better prospects for growth, because it is present in many immature markets. Yet its growth has stalled since a series of scandals brought close regulatory scrutiny, discouraged acquisitions and rattled management. BofA has hardly been unscathed by regulators, but it has not been hurt anything like as much. A scandal over mutual funds began with its dealings with a hedge fund, and it has been sued for its role in the financing of Parmalat, Enron and Adelphia, but all this has had little effect on its overall business.
From a distance, Citigroup and BofA are similar creatures. Both have grown to huge size through acquisitions. Both make about one-third of their profit from their corporate banks and most of the rest from consumers. Both have big shares of the credit-card market. Still, they are different animals on closer inspection. Citigroup sells complex investment products and has a big investment bank, operations in lots of countries and a tiny domestic retail franchise concentrated in three states, California, New York and Texas. It is not clear how these various bits fit together.
Bank of America, in contrast, lives up to its name. It makes almost all its money at home. Its sprawling branch network covers most of the heavily populated states. It has a vast banking business serving individuals and small firms, and a big share of the loan-syndication market. Much of what it does can be standardised and BofA goes to great lengths to discourage the kind of individualism that can produce great rewards but add huge risks.
In BofA, critics see a dull, if powerful, beast lumbering forward. Annual revenue growth per share has averaged only 6% in the past decade, notes Tom Brown, of Second Curve Capital, a hedge fund, and a long-standing critic. Institutions such as Downey Financial, in California, Flagstar Bank, in Michigan, and New York Community Bancorp have been growing at 17%.
All these banks are fairly small and have a narrow range of products: all relied heavily on mortgages in a strong housing market. BofA‘s defenders, notably its own management, contend that it has a uniquely strong and diversified franchise (at least in America) and that it is just beginning to exploit its reach, without depending on any one product.
It is not clear who has the better of this argument. According to SNL Financial, a research firm, big banks are making higher returns on equity than smaller ones. Among the biggest, BofA‘s are higher than most, though not as high as those of US Bancorp, Wells Fargo or (yes) Citigroup. The large banks, though, suffer from lower price/earnings ratios than smaller ones. That could be because the smaller banks carry a takeover premium; or it could be that the market doubts that large banks’ profitability can be sustained.
Being seen as a big, stodgy bank—even, you might say, something like a utility—is a novelty for BofA. Not long ago, it was anything but dull, expanding at an astronomical rate through one big deal after another.
Back in 1969 when Mr Lewis joined what was then known as North Carolina National Bank, it was not even among the largest institutions in North Carolina. The “national” in its headline was a regulatory nuance rather than a description. It had no branches outside the state.
Then it grew and grew. It is said that BofA has made more money for investors than any other company in the world (in second place is its Charlotte rival, now known as Wachovia). However, most of this money was made not by its own shareholders but by those of the banks it scooped up after rules blocking interstate banking were relaxed in the 1980s. Under one name or another, BofA was responsible for too many deals to count, from the purchase of First National Bank of Lake City, Florida (in 1982, for $6m) to those of Bank of America, then the name of a Californian institution (1998, $65 billion), and FleetBoston (2004, $48 billion).
Today’s bank is, by its own reckoning, the product of 3,000 combinations. That Mr Lewis’s institution was the survivor was a twist of fate; that the survivor came from a southern state was not. As the interstate bans were relaxed, southern regulators and banks worked together to ensure that big hunters from New York and California, among others, could not buy until local institutions had bulked up.
With the purchase of FleetBoston, the largest bank in New England, this strategy has run its course. Federal rules ban any bank from acquiring another if its market share of deposits is over 10%. BofA is now over the limit and may now expand only by growing internally. Others, though, will be buying. America is crawling with banks and they are perpetually consolidating. Mr Lewis forecasts that within five years there will be one or two more that are national, but for the first time, he is out of the market.
Where, then, will Bank of America find growth? There are some obvious guesses. Mr Lewis predicts that one or two big investment banks will be swallowed. Will BofA buy? He isn’t saying. But one of the bank’s maxims is that it has to be a big fish in a business, or not in it at all. It is certainly no giant in investment banking now. If it bought, it would have to integrate its purchase well, and its record is not good. BofA‘s investment-banking acquisitions of Robertson Stephens and Montgomery, two boutiques, were disastrous.
Another option is to look abroad. Having adhered to its maxim, the bank has little to build on. It dumped lots of small foreign businesses, picked up in the course of acquisitions. Joining forces with HSBC, which has big businesses in many places, may make sense on paper, but whether the two could work together is open to question. And BofA could not export its model of saturation coverage.
That leaves internal growth. The history of companies putting a long career of acquisition behind them is hardly encouraging. Citigroup is a case in point. After years of strong growth fuelled by its own buying binge, Citigroup has not yet learned to grow on its own.
In theory, BofA is well placed to exploit its size. It has a national franchise in a country where people are always on the move. Open an account in one state and there is no need to change banks if you cross the country—given the hassle, there is every reason not to. BofA‘s website has been an enormous hit, with 20m customers paying bills online.
A huge bank is a huge receptacle for cash. True, Americans are less likely these days to keep their savings in the bank, preferring money-market funds. But more than ever, they need bank accounts for transactions and BofA attracts loads of deposits, paying next to nothing in interest. Through its credit cards and accounts, encompassing 54m households and small businesses, the bank enjoys unusually good insight into America’s financial trends and thus has excellent, proprietary information that it can use to invest the money it has on hand.
All of this could lead to superior returns. Could. Like Citigroup, BofA must be aware that in banking, scale brings problems as well as profits. There is evidence that beyond a certain point scale is counter-productive. Outsiders will cheer too if BofA gets not merely bigger, but better.