Bank Of America - Financial Institution Analysis

Bank of America - Financial Institution Analysis
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Table of Contents TOC \o "1-3" \h \z \u Environment PAGEREF _Toc6074203 \h 3Risk environment PAGEREF _Toc6074204 \h 5Regulatory impact PAGEREF _Toc6074205 \h 9Influence of technology PAGEREF _Toc6074206 \h 10Influence of financial innovation PAGEREF _Toc6074207 \h 11Performance Analysis and interpretations PAGEREF _Toc6074208 \h 12References PAGEREF _Toc6074209 \h 17
Environment
Primary purpose
Financial analysis is necessary to evaluate study and interpret the accounting and financial reports of Bank of America (BAC) to assess its current financial situation and potential for growth. Financial ratios and other indicators help to make objective views about the corporation’s financial wellbeing while considering the impact of risk on financial performance current situation and how it is expected to be exchange in the future. As such, financial analysis is carried out through observation of the corporation’s financial statements in different financial years, and in this case 2016 to 2018. The ratios and other indicators together with additional information will help determine the areas that require improvement to enhance competitiveness and compliance with the regulatory frameworks.
Profitability, liquidity and solvency are the three common types of financial rations necessary for analysis, and there is focus on risk management to reduce exposure to market risks. Profitability reflects the difference between income and the expenses and higher profitability represents higher returns, while liquidity is the ability to pay the short-term obligation and solvency refers to the ability to meet long-term debts and also be able to invest to grow in the future.
Asset mix
The asset mix is the breakdown of all assets within the bank, and the assets can be assigned to one of the main asset classes: stocks, bonds, cash and real estate. A breakdown of the asset mix helps investors understand the composition of a portfolio. The asset mix is an important consideration for investors, and a key determinant of the risks the rewards, which also affect performance (SEC, 2019). The major classes of assets are: cash and equivalents, fixed income instruments and equity instruments. The total assets were $ 2,354,507,000 million in 2018, an increase from 2017, which was 2,281,234,000 million and 2,188,067,000 million in 2016. The loans and lease was the largest share of the assets at loans and lease at loans and lease million in 2018 and 936,749 million in 2017 compared to debt securities of 441,753 million and 440,130 million in 2018 and 2017. On the other hand, the Cash and cash equivalents were $ 177,404 M and $157,434M in the two years. The $73.3 billion total increase in assets from 2017 to 2018 was mostly because of “higher securities borrowed or purchased under agreements to resell due to investment of excess cash levels in higher yielding assets and increased client activity, and higher cash and cash equivalents driven by deposit growth” (BAC, 2019).
Economic functions performed
Banks like the Bank of America are financial institutions, which play a key role in the economic system and financial markets. The bank allows the transfer of money between savers, investors and borrowers. Bank of America accepts deposits and then lends the resources to borrowers, investors and the capital market, which facilitates various economic activities banks are the necessary connection between people and firms with capital deficit and those with surplus capital. Since individuals companies may not be in a position to finance their own development or liquidity requirements with the cash-flow they generate.
When the banks grant loans they face a credit risk of not recovering the credit and liquidity risk because of maturity of liabilities, interest rate risks, exchange rate volatility among others. Like in other banks, profitability, risk and liquidity reflect performance and are partly linked to economic performance. The banks also encourage saving and maintaining monetary stability. However, the bank also complies with the liquidity reserve requirements, which are the funds that each bank must have deposited in proportion to their deposits, for the security of their depositors.
Economic Value Added
The Economic Value Added (EVA) is a model that quantifies the creation of value that in a company during a certain period of time and reflects whether economic returns are higher than the cost of the financial structure. The EVA will depend on the net operating profit after taxes, cost of capital and invested capital. Total common shareholders’ equity was 242,999 M in 2018 compared to 244,823M in 2017, while the total shareholders’ equity was 265,325 million and 267,146 million in 2018 and 2017 respectively. The WACC at December 2018 was 8.77%. “The weighted-average effective interest rates for total long-term debt (excluding senior structured notes), total fixed-rate debt and total floating-rate debt were 3.29 percent, 3.66 percent and 2.26 percent, respectively, at December 31, 2018, and 3.44 percent, 3.87 percent and 1.49 percent, respectively, at December 31, 2017” (BAC, 2018)
* Net Operating Profit after Taxes (NOPAT) = EBIT- (1-Tax rate) = 34,584* (1- 18.6%)= 28, 147 M (same as net income)
* Invested Capital -Dec. 2017 358,627 and Invested Capital- Dec. 2018= 329,956- where Invested Capital is the book value of debt
* Economic profit (EVA) = NOPAT – Cost of capital × Invested capital 28, 147-8.77%*344291.50= -2047.36.
The Economic Value Added also reflects the expected future flows based on the current value of cash flows, and for the bank in 2018 there was negative EVA, which is a concern, as it is expected that corporations focus on future added economic values to improve profitability and financial performance.
Risk environment
Credit risk
Credit risk is probability that a customer or counterparty will default on the payments of their obligation. The potential losses from credit risk in the bank arise because of “loans and leases, deposit, overdrafts, derivatives, assets held-for-sale and unfunded lending commitments letters of credit and financial guarantees” (BAC, 2018). The bank classifies the portfolios as consumer or commercial and monitor credit risk to reduce exposure to this financial risk, which is one of the most common in banking institutions. Furthermore, since there is focus on identifying the risk profiles of different customer segments , individual customers and counterparties, BAC has been able to manage credit risks while considering changes in the business environment throughout the credit cycle.. The derivative liabilities were 37,891 million in 2018 compared to 34, 300 million in the previous year (BAC, 2018). The fair value option is sometimes in the case of some loans and unfunded commitments as are the derivative positions.
Interest rate risk
Interest rate risk is the exposures to instruments whose values changes depending on the interest rate levels or volatility. Some of these instruments, debt securities, derivatives loans, certain trading-related assets and liabilities, deposits and borrowings Hedging is used to mitigate these risks including derivatives such as options, futures, forwards and swaps (BAC, 2018). Changes and forecasts of net interest income help to determine the interact rate risk and based on the instantaneous parallel to the market-based forward rate this would be 2,651 in 2018 and 3,317 in 2017 for the positive parallel shift (BAC, 2018). The spot rate used for the forward rates was 1.50% in December 2017 and increased to 2.50% I the year ended 31 December 2018. Both the three-month LIBOR rate and 10 year swap were higher in the 2018 financial year compared to the previous year, forecasts on the net interest income change depending on the on business strategies , economic trends and market conditions (BAC, 2018).
Market Risk
Market risk exposure includes the different market conditions that affect the value of the assets or liabilities and even the earnings. These risks are present when using financial instruments and exposure to the global markers as well as foreign exchange exposures and commodity exposures (BAC, 2018). The company revaluates the changes in economic value and market conditions to reduce exposure to the market risks including the interest rate risks. In case of non-trading positions such as banking loan and deposit products, the bank manages the activities and considers the market-based r risk factors. For the bank’s trading positions that is reflected in the income changes BAC reports at fair value the market-based risk factors are mostly linked to changes in the foreign exchange rate, interest rate, equity, credit, and commodities markets (BAC, 2018). The bank is also exposed to trading risks at the global stage and global risk management has been prioritized to improve outcomes (BAC, 2018).Liquidity Risk
Liquidity risk reflects the ability to meet the liquid needs and supporting the business under different economic conditions the bank finances assets through the globally sourced deposits, the secured and unsecured liabilities transacted in the capital markets (SEC, 2019). There are also other funding sources like the repo markets, that are short-term and there are also in asset securitization transactions. there are no concerns about liquidity as the bank is able to access the capital markets and there were no unexpected outflows of cash despite; increased regulatory liquidity requirements in the US market, this has not affected the company’s liquidity positions, but there is a need to focus on what might affect business operations including the actions of credit ratings and market disruption in the home and international markets.
Operational Risk
Operational risks can cause losses due to human errors, inadequate or defective internal processes, systems failure and the consequence of external events. The operational risk includes legal risks, but excludes strategic and / or business risk and reputational risk (SEC, 2019). Operational risk is inherent to all activities, products, systems and processes. Operational risk management is important since the bank maintains diverse and complex financial services the calculation of total risk-weighted assets considers the operational risks and is based on the Basel 3 capital calculation (BAC, 2018). The Basel standardized approach includes the credit risk and market risk measures whereby indicators and scenarios provide insights on the level of operational risk (BAC, 2018). Identifying the risks in the business segments allows the bank to prioritize the risks incorporate the effect controls and link the risks to the processes, systems and events to establish the level of and identify gaps in risk management.
Foreign Exchange Risk
Foreign exchange risk is the positive or negative difference that arises from changes and volatility in the exchange rate over time. The bank conducts operations in another currency other than the U.S. dollar are exposed to foreign exchange movements. Similarly, “investments in non-U.S. subsidiaries, foreign currency-denominated loans and securities, future cash flows in foreign currencies arising from foreign exchange transactions, foreign currency-denominated debt and various foreign exchange derivatives require foreign exchang...