The financial crisis of 2008 still haunts investors, especially pertaining to mortgage-backed securities. However, more recently, the banking industry has experienced an upward trend with the push coming mainly from large banks. The trend seems to be global as emerging markets such as India and China follow similar trends.
From an investor’s point of view, now would be a good time to pick up banking stocks. It is always safer to side with the big players as the risk-return profile is relatively balanced. One such example is that of Bank of America Corp (NYSE:BAC), the second largest U.S. lender operating on a global scale.
Growth prospects
Last year, Bank of America Corp (NYSE:BAC) refused to touch new mortgages focusing on refinancing home loans. Now that real estate prices have picked up, management decided to revisit its roots. The change is expected to turn the losses in the real estate segment into a profit. The bank is likely to benefit from the growing liquidity in the residential real estate market. Management is confident about the future of this market as it cuts down its provision for losses in this segment. Furthermore, it cut down expenses for delinquent mortgages by $1 billion per quarter by the end of this year.
One of the most favorable changes taking place in the economy that will increase profitability in the banking sector in general are the rising interest rates. Interest spreads i.e. the difference between cost of lending and borrowing are the core source of revenue for any bank. For Bank of America Corp (NYSE:BAC), cost of borrowing is denoted by the Federal Funds rate, which has remained stable in the past few years and the Fed seems to have no intention of changing it. On the other hand, the rise in market rates provides the bank with the opportunity to increase the rate charged on loans and advances. The increase in the net interest margin will culminate in higher profits.
Litigation costs for the bank have proved to be a great threat to its profitability. In April, the bank settled its three mortgage-backed securities lawsuits related to the Countrywide unit worth $500 million. The business is expected to eliminate almost 90% of its existing mortgage issues as per statutory requirement.
Other attractive investments in the sector
The banking sector is one of the growing sectors at the moment as most of the banks enter the rapid recovery stage after the financial crisis of 2008. As a result, there are a lot of attractive investments available in the sector. Citigroup Inc (NYSE:C) is another giant making its way out of the shambles of 2008. The bank has made substantial recovery and a rise of 30% in profits during the last quarter indicates that the bank is progressing well.
The biggest drag for most of the banks has been the mortgage portfolio, and most of these banks have been trying to get rid of this drag. Citigroup Inc (NYSE:C) recently negotiated a $968 million mortgage claim settlement with Fannie Mae to resolve potential future repurchase claims for breaches of representations and warranties on 3.7 million residential first mortgage loans sold to Fannie Mae. The payment was covered by the already existing mortgage repurchase reserves of the bank.
The third stock to consider in the banking sector is Goldman Sachs Group Inc (NYSE:GS). There has been a shift in focus towards cost efficient operations instead of top line growth by all the major players in the industry. Goldman Sachs Group Inc (NYSE:GS) has been successful in pursuing its cost cutting measures and the bank has been able to report impressive earnings. Most of the segments of Goldman Sachs Group Inc (NYSE:GS) are performing well now and with the cost cutting measures in place, earnings should improve further. Furthermore, an upward trend in the economy and the housing sector should augment the revenue and play a vital role in the recovery of these banks.
Conclusion
As I have mentioned above, the system is stronger at the moment and provides a better platform for the banks to operate. In addition, the economic recovery is gathering pace, which should allow the banks to bring in higher income. The weakest segment of the economy over the past five years, the housing sector, also seems to be doing well, which will result in higher income from Bank of America Corp (NYSE:BAC)’s real estate segment. Overall, I believe that the bank is ready to appreciate further.
Ishtiaq Ahmed has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Goldman Sachs. The Motley Fool owns shares of Bank of America and Citigroup Inc (NYSE:C). Ishtiaq is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Is Bank of America a Good Investment? originally appeared on Fool.com is written by Ishtiaq Ahmed.
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