Monday, July 7, 2014

* Banks - What Drives Returns & Why Bank of America is Different than any Other Bank.

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The "big four" bank Symbol Summaries are included below.

Provided by Livevol

There is a general misconception (in my opinion) that the big four banks in the United States are really one in the same.  I would like to demonstrate an alternate option, with facts.

Fact #1: As we approach earnings, the option market reflects higher risk in BAC than any of the other big four banks.  The Symbol Summaries above are actually listed in order of risk from lowest (WFC) to highest (BAC); see the yellow boxed IV30™ values.

A big part of this risk for BAC is its (Non-performing Loans) / (Total Loans ) which when compared to US and Canadian Banks over $5B market cap, is the single largest.

NB: The implied volatility is the forward looking risk in the equity price as reflected by the option market (IV30™ looks forward exactly 30 calendar days).

Here's a chart:

Provided by Livevol

BAC is riskier than the rest of the big four and has substantially higher stock returns than the big four. Further, BAC when compared to a peer group of 100+ banks (details below), has absurdly higher earnings from continuing operations 1-year growth, and it's that measure that may be driving stock returns.

Fact #2: The stock returns of the big four have been dramatically different over the last two-years.

Here is the two-year stock price chart for all "big four."

Provided by Charles Schwab optionsXpress

BAC has vastly outperformed the rest of the group, nearly doubling the return in WFC and JPM.  The question is, why?

Fact #3:  Earnings from continuing operations 1-year growth have been significantly different across the group and it's this measure that appears to be the driver in stock price.

The peer group I have chosen is:
  1. Total Assets > $10 billion
  2. North American banks
  3. Exclude Fannie Mae and Freddie Mac
Here are two ways to look at that measure.  First a very simple horizontal chart.  We can see that among this rather large peer group, BAC wildly outperforms all other banks.

But that horizontal chart is a bit sophomoric in-and-of-itself. Let's turn to a scatter plot, with the earnings measure 1 year growth on the vertical axis and total assets as the horizontal axis.

I have called out a few banks on the scatter plot, namely the big four, and three "dots" that looked interesting (PNC, FNFG and TCF).

We can see very easily that BAC blows away the big four, and really, any and all other banks in this peer group.

Is it a surprise that "Earnings from continuing operations 1-year growth" is a good measure of a stock's return: No.

Is it a surprise that BAC blows away any other bank of almost any size. Yes.

And, back to the very beginning.  Is it as surprise that BAC has vastly more risk as reflected by the option market than the other big four? No.

You still think all big banks are the same? Your turn to answer.

This is trade analysis, not a recommendation.

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