The Year 2016 Could Be A Year Of Bank Of America Corp (BAC) And Citigroup Inc (C)

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It was undoubtedly a big disappointment for Bank of America Corp (NYSE:BAC), as well as Citigroup Inc (NYSE:C) and all financial institutions that the Fed failed to hike its interest rates. Most of the analysts were expecting interest rate hikes that would have benefited them the most. In fact, the bigger banks in the United States were fed up with the Federal Reserve Chief Janet Yellen. As a result, some of the analysts termed the outlook as worse even for the big banks. On their part, banks have started moving their cash to long-term assets. However, there is something to cheer up the market, as well as the financial institutions. Yellen said that the central bank was on target to announce an interest rate hike in the current year. Therefore, the effect of them can be seen only next year. That means the next year will be the year of the Banks.

Suffered Miscalculations

There is no doubt that Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) have come a long way after the financial crisis struck the financial industry. Both have experienced several issues holding back capital returns in recent years. While Bank of America suffered due to miscalculations in respect of the CCAR, Citigroup could not pass the stress test for qualitative reasons in the past. However, both of them worked harder to build capital and worked their way to add strength to their balance sheets in the last few years. As a result and the expected benefit from the interest rates next year, the year 2016 will turn out to be crucial for the financial sector and the two banks.

Also, that should enable Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) to resort to increasing dividends, as well as the buybacks next year. However, the comments made by Yellen hold key and will dictate the course of action. She said that the Fed would allow the labor market to run hot for a time. She said that she was in favor of hiking the interest rates in the current year itself. Most of her colleagues were also anticipating an interest rate hike in the current year itself.

Bank of America Corp (NYSE:BAC)

The company’s board and its CEO, Brian Moynihan, achieved a major battle with the activists’ shareholders by retaining the chairmanship position also. The board and Moynihan were driven to the situation to seek a vote from Shareholders. Moynihan indicated that the bank’s income was levered two-thirds to short term rates while the rest went to long-term. Also, the 100 basis points increase in interest rates could result in $3 – $4 billion change in income, subject to other things remaining equal. Though 100 basis points in rate hike are not expected, a minimum rate increase of 25 basis points can be expected before the current calendar year ends. That will result in a maximum $1 billion and a minimum of $750 million in income to the bank for a year.

Similarly, Bank of America Corp (NYSE:BAC)’s maintaining the current methodology on standardized RWAs, it can have a major portion as a capital buffer over the minimum needs based on the Dodd-Frank stress tests. Given the recent changes, the bank should have a lot of capacity on the quantitative side. That is supported by the strong result of CCAR as indicated in its most recent 10-Q. The bank is generating a considerable capital from its core units and expects a drop in legacy assets, as well as operational risk RWAs. As a result, the capital return potential is huge over time. The bank canceled its $4 billion share buyback program last year. However, the bank might come up with a bigger share buyback program next year as profit will surge in the current year in the absence of any charges.

Citigroup Inc (NYSE:C)

This is one more bank that was forced to seek the government’s bailout package in 2008. The bank is already operating at a CET1 ratio of 11.4%. The company has probably exceeded its binding constraint. The company was in an enviable situation in the form of a capital return perspective while leading the industry.

Citigroup Inc (NYSE:C) said that investors can expect an increased capital ask compared to the $7.8 billion approved in the current year. While tangible book value per share was $59.18, book value per share reached $68.27 at the end of the second quarter. At the current trading price of around $49.8, shares are trading at a discount of 15.8% to tangible book value per share and 27% compared to the book value per share. The company has also been reducing its expenses. The bank has bought back 28 million shares in the second quarter and returned $1.7 billion to its shareholders in the form of dividends and share buybacks.

At least two brokerages, Jefferies and Credit Suisse, have upgraded the shares of Citigroup Inc (NYSE:C) to a rating of Buy and Outperform respectively. Similarly, they have kept a price objective of $60 and $62 respectively on the shares of the bank. The company will have to continue buying back its shares and boost its dividend next year.

Conclusion

Bank of America Corp (NYSE:BAC) and Citigroup Inc (NYSE:C) are going to be the beneficiaries of the interest rate hike, which will happen. The policy makers feared that the interest rate hike would further harden the dollar and held back their decision. However, they have to hike the interest rates if not in September but sometime in the coming months. Once the Fed starts the process of interest rate increase, the confidence on the banking stocks will improve. At that point of time, stocks will look at an elevated level while the current level might look better options to buy.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Viraj Shah

Viraj Shah has completed M.Com (Finance) and is currently pursuing his CFP. He tracks US markets along with other global markets like India very closely. He is very passionate about stocks, real estate, and technology. He also believes that money can always be made in the market.

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