Analysis of Bank of America Corporation
By Justin DeMerchant, Prashant Pradhan, Mika Sakamoto, Jake Saunders, & Tony von Richter
Executive Summary
The Bank of America Corporation (BAC) has had a long history of success in the banking and finance industries, however the financial crisis of 2008 created significant problems for the company. The economic meltdown caused by the subprime mortgage crisis led to huge losses for BAC. The further deregulation of the financial industry allowed management to invest in default credit swaps as well as complicated mathematical derivative models to value risk, which led to the company issuing ill-advised loans, which could subsequently not be repaid. The company's personal banking services were also affected as increasing levels of unemployment resulted in lower amounts of money being deposited with the bank.
The financial industry also caused the company problems in the recent past. The large amount of loan defaults resulted in significant losses for the company. The lack of liquidity in the economy due to the global credit crunch restricted the lending opportunities for the company. As credit became available the public withdrew money from the market causing a downward spiral in the financial industry.
Even though BAC was not as exposed to the subprime mortgage crisis compared to other financial institutions the financial meltdown still gravely affected the company. Credit default swaps resulted in write-downs of $5.28 billion in the first quarter of 2008. The company did not have the liquidity to cover short-term liabilities necessitating the injection of government funding. The acquisition of Merrill-Lynch added to the hardship already plaguing BAC, and was mired in controversy because of questionable actions by BAC executives.
The company is still presented with opportunities although it has suffered difficulties in the recent past. If the company can pay back taxpayer funding, develop a contingency plan for the increasing regulation of the credit card industry, institute better transparency and auditing policies for the company, and make other changes it can thrive for years to come.
1a - Corporate Development and Strategy & 4a - What Happened in 2008 & 2009? (Justin DeMerchant)
The Bank of America has a history filled with mergers and acquisitions. Its first ancestor was the Massachusetts Bank that opened on July 5, 1784 , but its main chain of history began with the founding of the Bank of Italy in San Francisco in 1904. In 1927 the Bank of Italy merged with the Liberty Bank of America creating the Bank of Italy National Trust & Savings Association. The Liberty Bank then merged with the Bank of America Los Angeles becoming the largest banking institution in the United States called the Bank of America. At this point Bank of America was the largest bank in the country.
Throughout the 1950s banking regulation had a large impact of the Bank of America. First it was forced to separate from its parent company, the Transamerica Corporation, by the Clayton Antitrust Act . In 1956 the Bank Holding Company Act prohibited BACs interstate banking, forcing the divestment of banks outside of California into a separate company called First Interstate Bancorp.
In 1958 technology allowed BAC to develop a credit card called BankAmericard (later to become known as Visa) . They mailed 60,000 cards out to clients unsolicited.
Later, in 1967, following amendments to the Bank Holding Company Act which again allowed interstate banking, BankAmerica Corporation (BA) was created to hold BAC and its subsidiaries. With the lift of the interstate banking ban, BAC begin an aggressive strategy of buying its way into attractive domestic markets on its way to becoming a nationwide bank.
President Jimmy Carter's Depository Institutions Deregulation and Monetary Control Act of 1980 was sold to the pubic as a benefit for consumers, but was really a gift to the banking sector . Mandatory reserve requirements were lowered and high 'caps' were placed on rates that could be charged on residential mortgages among other things. Further deregulation came with the election of Ronald Regan and the Garn-St. Garmain Depository Institutions Act.
In 1988 the Basel Accord was established that made it easy for marketable securities to be sold, essentially freeing up banks from having to back their mortgage obligations with real cash . A year later Wendy Gramm was appointed as chairperson to the U.S. Commodities Futures Trading Commission and successfully exempted swaps and derivates from federal regulation in 1989.
BA acquired Seafirst Corporation in 1983, and Security Pacific and Valley Bank in 1992. In 1994 BA purchased Continental Illinois National Bank and Trust Co. from the federal government, again becoming the largest banking company in America before falling to number two in 1997 and three in 1998.
In 1999 proponents of deregulation won their ultimate victory with the enactment of the Gramm-Leach-Bliley Financial Services Modernization Act , which essentially did away with the Glass-Steagall Act of 1933 that separated risky investment banks from commercial banks and the Bank Holding Company Act of 1956 . This essentially opened the door for subprime lending of which Senator Phil Gramm famously said "I look at subprime lending and I see the American Dream in action." While these practices promised huge returns, BAC stayed largely out of the subprime mortgage market but they were still exposed to much of the risk through their ownership of collateralized debt obligations.
The NationsBank Corporation bought BA in September 1998 for $64.8 billion , although it was structured more like a merger. They operated under the name Bank of America Corporation, and operated under the charter granted to the Bank of Italy back in 1927 . The newly formed BAC was forced to divest 13 branches in New Mexico because banking regulation dictates that that cannot have more than a 25% deposit share in any one state.
In the 21st century BAC continued with its acquisitions. BAC bought FleetBoston Financial in 2004 which was the nations 7th largest bank. This was somewhat of a reversal of Ken Lewis' position that BAC was going to focus on growing organically from the inside. With the purchase BAC effectively bought its way into New England where it had previously had only a small presence .
This point seems to mark a change in BAC's acquisition strategy. They focus less on horizontal growth through acquiring banks that offer similar services in geographic locations that they only had a small presence in to focusing on vertical growth into services peripheral to consumer banking. This seems to be out of necessity for a few reasons. First they are at this point of bona fide national bank with a strong presence in most of the country. Secondly at this point they are approaching state and federal caps limiting how much of a market one bank can control.
Their next target was MBNA, a credit card giant with over 40 million US accounts , which was bought on June 30, 2005. The combination of the two companies created a large deal of savings, estimated at $850 million and made them one of the world's largest credit card issuers. This also helped BOA raise revenues in the card services division by almost $11 billon from 2005 to 2006 following the full integration.
The United States Trust Company (UST) was acquired from Charles Schwab on November 20, 2006 . This acquisition was a strategic decision by BAC in an effort to gain a strong presence in the high-end 'private' banking sector where UST was the third largest bank behind J.P. Morgan and Citibank .
A large stake in Countrywide Finance (CF) was bought on August 23, 2007 with the purchase of $2 billion in preferred shares yielding 7.25% annually. Along with this purchase came the right to match any other offer to buy CF in the future and it was speculated BAC would likely exercise this right at some point .
LaSalle Bank was purchased on September 14, 2007 from ABN AMRO, a Dutch bank, which increased BAC presence in central USA, particularly Boston . There were concerns that this would push BAC over the 10% federally imposed cap on all domestic deposits, but this has not been an issue aside from precluding BAC from buying any more banks in 2008, possibly longer .
On January 11, 2008 BAC announced their plan to purchase the rest of CF (on top of the $2 billion in preferred shares they acquired in 2007), which was completed on July 1, 2008 for $2.5 billion . CF has since been rebranded as Bank of America Home Loans.
President George W. Bush signed the Economic Stimulus Act of 2008 into force on February 13, 2008 following testimony by Federal Reserve Chairman Ben Bernanke that the United States would fall into a recession unless they took action . The legislation aimed to decrease the tax burden for low and middle-income families, to stimulate small business investment, and to raise the limits on mortgages that were eligible for government purchase.
On July 30, 2008 the Housing and Economic Recovery Act of 2008 was signed into effect . The act was aimed at restoring confidence in the mortgage sector (namely Fannie Mae and Freddie Mac) by extending federal guarantees worth $300 billion over 30 year subprime mortgages . The bill also established the Federal Housing Finance Agency, which took effective control of Fannie Mae and Freddie Mac on September 7, 2008 .
BAC then announced its plan to purchase Merrill Lynch & Co., Inc. (ML) on September 15, 2008 . On the same day Lehman Brothers (LB) filed for Chapter 11 bankruptcy protection. It was widely speculated that BAC had intended to purchase either ML or LB , and with other financial institutions backing off of LB it was apparent that no one was going to save them.
The Emergency Economic Stabilization Act of 2008 was enacted on October 3, 2008 . It was created to authorize the United States Treasury Department to spend up to $700 billion to bail out the financial sector by buying up mortgage backed securities and making capital injections into banks . When the law was enacted it established the Troubled Asset Relief Program (TARP), which is the subject of section 4b of this study .
The deal to buy ML closed on January 1, 2009, after gaining the support of both companies' shareholders, and is thought to have saved ML from bankruptcy . On January 16 massive fourth quarter losses by ML in the amount of $15.31 billion were reported . The deal was controversial after it came to light that federal officials pressured BAC CEO Kenneth Lewis into the deal , and that BAC tried to back out of the deal once the full extent of the losses were known.
Shortly after his inauguration on January 20, 2009 President Barack Obama signed the American Recovery and Reinvestment Act of 2009 into effect on February 17, 2009 . The $787 billion act invested in many social areas such as tax cuts to low-income earners, unemployment benefits, health care, and infrastructure .
The Securities and Exchange Commission came to a $33 million settlement with BAC on August 3, 2009 because they failed to disclose an agreement to pay out $5.8 billion in bonuses to employees of ML. Federal judge Jed Rakoff subsequently rejected this agreement on August 5, 2009 . The trial is set to begin on February 1, 2010.
1b - Mission / Vision (Justin DeMerchant)
BAC does not have a clear accessible mission statement. Its website is riddled with statements one would expect about providing value to all stakeholders and corporate responsibility, but there fails to be a unifying message. Looking further into press releases and financial statements you can begin to get a picture about the vision the company has for itself.
In 2004 Chad Gifford, then Chairman of BOA gave the most clear articulation of what exactly the BOA is when he said:
Our goal is to provide our shareholders consistent, attractive earnings growth and high levels of profitability. On our own, I believe we would have continued to gain strength and momentum, and that the progress we're making with all our customer groups, from consumers and small businesses to middle-market and large corporate clients, would have driven significant improvements in both top- and bottom-line growth. With the addition of the former Fleet franchise, I believe our future prospects are brighter still.
The 2008 financial statements give some one-liners like "We are building a global financial services company that offers our customers and clients unmatched convenience and expertise, high-quality service and a variety of financial products and services delivered as a single relationship."
The lack of a clear mission or vision statement by BAC is a problem that many large companies suffer from. A clear mission would give employees a framework from which to make decisions, and a clear vision would tell them where BAC wants to go. Essentially forcing people to synthesize their own view on how the company operates can lead to people working in different directions.
1c - Overview of Strategic Profile
BAC segments its offerings into three distinct groups that span the range of banking services; Global Consumer and Small Business Banking (GCSBB), Global Corporate and Investment Banking (GCIB), and Global Wealth and Investment Management (GWIM). Within each division they have many product offerings (See Exhibit 2 for product offerings ).
As a bank it is important that BAC offer a broad scope of services to meet the desire of customers to have a one-stop shop for bundled financial services. This is an advantage they have over niche competitors, which offer specialized services like investing or insurance. Because customers expect a wide range of services, BAC may be forced to offer a service even if it is a loss leader.
There are many synergies possible between the three business units. The units can each leverage the resources of the others both in capital resources and intangible resources like competences and customer information. With the wide range of services being offered by the business units the firm can increase its bargaining power by offering a full range of financial services. There are also integrating activities that can be used to create additional value such as the firm launching joint advertising campaigns for all its units.
1d - Evolution of U.S. Banking Regulations
A sound financial system is indispensable for the smooth functioning of an economy or the country as a whole. As such in order to ensure smooth functioning of banking systems, they are highly regulated. However keeping in mind the changing needs of the economy and the different players in the market, the banking regulations have evolved over a period of time. Banks in the United States are regulated by both state and federal law. The states have been regulating banks since 1789 when the Constitution gave states the right to charter banks as well as to regulate their activities. It was Alexander Hamilton who advocated the creation of a federally chartered bank. The 1927 McFadden Act stated the right of the states over the regulation of national bank’s branching activities within their borders. Although deregulation of branching restrictions in the 1930s did exist, most states continued to enforce these policies into the 1970s where only 12 states allowed unrestricted statewide branching in 1970. However, between 1970 and 1994, 38 states deregulated their restrictions on branching. Reform of restrictions on intrastate branching was implemented in two stages. First, states allowed multi-bank holding companies to convert subsidiary banks into branches and then expand geographically by acquiring banks and converting them into branches. Secondly states permitted de novo branching, whereby banks could open new branches anywhere within state borders. The first steps towards change were initiated by Maine in 1978 when it passed a law allowing entry by out-of-state bank holding companies if, in return, banks from Maine were allowed to enter those states (entry in this case means the ability to purchase existing banks, not to enter de novo). However no state reciprocated, and as such interstate deregulation process remained stalled until 1982 at which point Alaska and New York passed laws similar to Maine’s. Deregulation of interstate banking was complete by 1992 when all states but Hawaii had passed laws similar to those passed in Maine. With the passage of the Reigle-Neal Interstate Banking and Branching Efficiency Act of 1994, which effectively permitted banks and holding companies to enter another state without permission, the transition to full interstate banking was completed.
The existence of Federal deposit insurance in the United States dates back to 1933, when Congress passed a series of laws aimed at restoring confidence in the financial and banking systems. Due to the high number of bank failures during the 1980s and early 1990s, increment in the amount of deposit insurance coverage was capped. For example the federal insurer of thrift deposits became the Federal Savings and Loan Insurance Association. As such Federal Savings and Loan Insurance Association were liquated and Federal Depository Insurance Corporation was handed over the responsibility of insurance for deposits. Due to such failures on the part of deposit insurance, The Federal Depository Insurance Corporation Improvement Act of 1991 introduced risk-based premiums and provisions to handle failed banks in the least costly way to Federal Depository Insurance Corporation. The latter provision was made primarily due to failure of large banks such as Continental Illinois and Bank of New England, which failed during the 1980s and all creditors were paid in order to avoid adverse chain effect in the economy. These banks were considered to be too big to fail by the comptroller of currency. The Federal Depository Insurance Corporation Improvement Act had also introduced policies outlining quick corrective actions whereby regulators are required to respond quickly and not hold back as banks fall into trouble. Due to the growth in bank deposits, it has pushed the Bank Insurance Fund to near the 1.25 percent reserve limit, which led to the passage of Federal Deposit Insurance Reform Act of 2005, which is a part of a Deficit Reduction Act of 2005 that was signed into law on February 8, 2006. With the implementation of this Act, new Deposit Insurance Fund was formed after merging the old Bank Insurance Fund with the Savings Institution Insurance Fund which increased deposit insurance for retirement accounts to $250,000, provided for the adjustment of deposit insurance limits for inflation beginning in April 2010, and increased the Federal Depository Insurance Corporation’s flexibility in setting risk-based premiums.
With the passage of the Banking Act of 1933, a clear outline was laid out restricting banks involvement in underwriting, insurance and other ‘non-bank’ financial activities. The sections of the Act that separate banking and non-banking activity are collectively known as the Glass-Steagall Act. The Bank Holding Company Act of 1956 (and the Amendment to the Act in 1970) further outlined the difference between banks, insurance, and securities firms. After mid-1980s the Federal Reserve and the Office of the Comptroller of Currency began loosening restrictions on bank participation in investment banking and insurance. Even though Glass-Steagall and other banking acts did not allow underwriting, certain securities such as municipal general obligation bonds, U.S. government bonds, and real estate bonds were exempted and banks could underwrite these securities. On January 18, 1989, the Federal Reserve allowed the ‘Section 20 subsidiaries’ to underwrite corporate debt and equity securities contingent on the 5 percent revenue limitation which was subsequently increased to 10 percent and 25 percent of their revenue. The Federal Reserve enforced firewalls between banking and non-banking activity within the subsidiary structure of the Bank Holding Company. With the implementation of the Financial Modernization Act in 1999, which was also known as Gramm-Leach-Bliley Act, it allowed Financial Holding Companies to own affiliates engaged in banking, insurance underwriting and securities activities. With the passage of this act the lines between a commercial and investment bank has increasingly blurred .
Regulations pertaining to minimum capital required to be maintained by banks have evolved over time. Initially banks capital adequacy was measured based on raw ratio of equity capital to total assets. However this ratio ignored off balance sheet activities such as credit guarantees and unfunded loan commitments. To overcome this deficiency, the 1988 Basel Accord was implemented to address the problem of raw ratio. With the growing complexity of the financial market such as such as securitization and credit derivatives in the late 1990s it has become easy for banks to trade risk, the Basel II Accord, which are based on three principles that focus on trying to update capital requirements, ensure effective regulatory supervision, and enhance the role of market discipline, is recommended by international banking supervisors .
1e - Deregulation of Financial Sector (by Prashant Pradhan)
The Glass-Steagall Act of 1933, officially known as the Banking Act of 1933, was the guiding principle on which the U.S. banking system was developed since the great depression in 1930s. The introduction of Depository Institutions Deregulation and Monetary Control Act of 1980 initiated the first major reform of banking sector in the United States. The implementation of this act lowered the mandatory reserve requirements banks keep in non-interest bearing accounts at U.S. Federal Reserve banks; established a five-member committee, the Depository Institutions Deregulation Committee, to phase out federal interest rate ceilings on deposit accounts over a six-year period; increased Federal Deposit Insurance Corporation coverage from $40,000 to $100,000; allowed depository institutions, including savings and loans and other thrift institutions, access to the Federal Reserve Discount Window for credit advances; and pre-empted state usury laws that limited the rates lenders could charge on residential mortgage loans. Staying in tune with the reforms in the banking sector, during the tenure of President Ronald Regan Garn-St. Germain Depository Institutions Act was introduced which deregulated the saving and loan industry. This is considered to be one reason for the savings and loan crisis in 1982. The provisions of the act allowed savings and loans to make commercial, corporate, business or agricultural loans of up to 10% of their assets and authorized a capital assistance program – the “Net Worth Certificate Program” – for dangerously undercapitalized banks, under which the Federal Savings and Loan Insurance Corporation and the Federal Depository Insurance Corporation would purchase capital instruments called “Net Worth Certificates” from savings institutions with net worth/asset ratios of less than 3.0%. The Federal Savings and Loan Insurance Corporation would theoretically later redeem the certificates as these shaky banks regained financial health and raised the allowable ceiling on direct investments by savings institutions in nonresidential real estate from 20% to 40% of assets1. In 1988 Basel Accord-I was introduced which determined the minimum capital that banks should have based on the risky assets held by deposit taking commercial banks. According to Basel Accord-I banks were required to hold reserves based on the risk of the loans. For example if tenure of the loan was long and illiquid in nature, they were required to put in more reserves for such loans than for loans, which are short term in nature and liquid. However banks were able to overcome this requirement by bundling the loans and holding them in securitized form, which required banks to make less provision because securities were considered to be liquid.
The deregulations of the banking industry was further promoted with the acquisition of Citi Bank by Travelers which resulted in the combination of commercial bank with the investment bank which violated the principles of Glass-Steagall Act and Bank Holding Company Act of 1956. According to Glass-Steagall Act it separated banks based on the type of business carried on by them as the risks differed based on the business. As such combining two banks which catered to different business exposed customer of commercial bank to risk of investment banking which had significantly higher risk resulting from securities related activities. However the introduction of Gramm-Leach-Bliley Financial Services Modernization Act in 1999 by President Bill Clinton, which allowed commercial banks, investment banks, securities firms and insurance companies to consolidate, the acquisition of Citi Bank by Travelers was complete. Meanwhile, over at the U.S. Commodities Futures Trading Commission, the appointment of free-market disciple Wendy Gramm as chairperson, who later went on to be a board member of Enron Corporation as a member of audit committee, would result in her successful 1989 and 1993 exemption of swaps and derivatives from all regulation.
2a - Nature of the Business and its Significance
Undoubtedly one of the major portions of the American economy is the services offered by the banking industry. In large part the stability of the American economy is tied up in the success of the banking industry otherwise the American government would not have provided funding to certain firms to help ensure that they continued to operate during the financial crisis. The three main components of the banking and financial industry are mortgage banking, investment banking, and personal banking.
Mortgage Banking
With about 7,000 firms and annual revenue between 50 and 75 billion the mortgage industry is a significant player in the American economy. Some of the major competitors to BAC are Citigroup and Wells Fargo, who, along with the other top 50 firms in the industry, account for 70 percent of mortgage revenue.
Obviously the biggest function of the mortgage industry is to provide funding for people to purchase homes. For the most part this is done on a fixed interest rate basis, usually spread over 30 years. Recently subprime mortgages became popular offering funding to people who wouldn’t have qualified for traditional mortgages. As we now know this ended up helping cause the financial crisis in the United States that began in September 2008.
Investment Banking
The investment banking industry falls between the mortgage and personal banking industry with $100 billion in annual revenue. It is also the most heavily concentrated of the three industries with the 50 largest firms accounting for 90 percent of the industry’s revenue.
Main activity of the industry is to supply capital to businesses so they can fund their operations or expand via mergers and acquisitions. The success of these firms is dependent on their ability to successfully determine which companies will be able to pay back this capital. In terms of revenue within the industry 50 percent comes from trading activities, 35 percent from asset management, and 15 percent from merger and acquisition fees and public offerings.
Personal Banking
The personal banking industry is without question one of the largest in the American economy with around $630 billion in revenue annually. This revenue is split over 7,100 commercial banks, 1,200 savings banks, and 8,000 credit unions. Revenue is split with 81 percent coming from commercial banks, 13 percent coming from savings banks, and the remaining 6 percent coming from credit unions. Similar to the mortgage industry the 50 largest firms account for 60 percent of the industry’s revenue.
Like any other operation banking industry relies upon efficient operations. Of course the industry is quite capital intensive which only makes sense given the nature of the business; it is also quite automated due to the high amount of data that is generated on a daily basis. One of the most important aspects of the business is risk management as one of the industry’s main products is giving out money through loans. Banks need to successfully evaluate who will be able to pay back the money they are loaned (as well as the interest that is charged along with it).
BAC is involved in the three areas of the banking and financial industry, however the company separates and structures its operations differently than described above. For the recent past until 2009 BAC divided operations into three areas: Global Consumer and Small Business Banking (GCSBB), Global Corporate and Investment Banking (GCIB), and Global Wealth and Investment Management (GWIM).
Global Consumer and Small Business Banking includes deposits and student lending ($20,649 million in revenue in 2008), card services ($28,433 million in revenue in 2008), mortgage, home equity, and insurance services ($9,262 million in revenue in 2008). In 2008 this section of the business accounted for 79 percent of BAC's total revenues.
Global Corporate and Investment Banking includes business lending ($7,823 million in revenue in 2008), capital markets and advisory services (a loss of $3,018 million in 2008), treasury services ($7,784 million in revenue in 2008), and asset and liability management ($851 million in revenue in 2008). In 2008 this section of the company accounted for 18 percent of BAC's total revenues.
Global Wealth and Investment Management includes U.S. Trust, Bank of America Private Wealth Management ($2,650 million in revenue in 2008), Columbia Management ($391 million in revenue in 2008), Premier Banking and Investments ($3,201 million in revenue in 2008), and asset and liability management ($1,543 million in revenue in 2008). In 2008 this section of the company accounted for 11 percent of BAC's total revenues.
In terms of net income, the GCSBB division posted net income of $4,234 million which accounted for 106 percent of the company's total. The GCIB division posted a net loss of $14 million, which was one percent of the company's total net income. GWIM division posted revenues of $1,416 million, 35 percent of the company's total in 2008. Interestingly enough, the a major portion of the company's losses, $1,628 million or 40% of the total, came from areas of the company outside of the three main divisions. These other areas consisted of merger and restructuring costs, the liquidation of certain businesses, equity investments, and activities associated with the residential mortgage portfolio.
Tangible and Intangible resources
Each company in the industry will have their own specific competencies the industry generally has similar types of tangible and intangible resources.
Tangible resources would be the capital available to the company, either through their own reserves or the deposits and funds available to them from their clients. Capital investments such as offices, branch locations, automated teller machines, etc. would also be considered tangible resources.
Other than the capital available to the company the intangible resources in the banking and finance industry are arguably of more importance. These intangible resources can be broken down into two main areas: relationships and competencies.
Relationships can include the direct relationship with consumers, whether they are individual consumers or businesses, and the... A firm's reputation can also be considered a relationship-based intangible asset. For BAC this could include being known as a top personal and commercial banking firm, and also their status as an innovator in the industry.
In terms of competencies generally they can be categorized as knowledge or capabilities. Knowledge refers to the information that a firm possesses in various segments of the industry (personal banking, small business banking, card services, etc.). Capabilities refer to a firm's ability to utilize the knowledge it possesses to participate in a particular market segment. An example for BAC would be its wealth management business. In acquiring Merrill Lynch, BAC is now able to utilize its knowledge of the wealth management industry (as well as the knowledge gained by acquiring Merrill Lynch), as it now possesses Merrill Lynch's capabilities in the wealth management sector.
2b - Barriers to Entry and Exit (by Tony von Richter)
There are significant barriers to entry in the banking and financial sector. Primarily these barriers are based on government regulation, capital requirements, and switching costs to the consumer.
In terms of government regulations of most significance is the Basel II accord, which is the second of the Basel Accords issued by the Basel Committee on Banking Supervision. The Basel II accord is outlined in more detail above in section 1-d, however it is mostly concerned with setting minimal capital requirements for banks.
Obviously the capital required for operating a company in the banking and financial industry is quite significant. Obviously not every firm would be as large as BAC nor would they require as much capital, however the nature of the industry requires large amounts of capital be available. Each company operates differently however a large portion of a company’s assets are loaned out at any one time which makes operating a company extremely difficult without significantly high assets.
2c - Customer Groups (by Mika Sakamoto)
It seems that BAC frames two segments as its customers, personal banking and corporate banking. In addition, BAC covers two different language groups: English speakers and Spanish speakers.
Personal Banking
There are four types of personal banking services: regular personal banking, life-stage based services, monetary status based services, and the specific services for the certain occupations.
Regular Personal Banking Service
The first service group is the regular personal banking service, which includes checking, savings, and credit card. These services are provided by BAC. For the credit card service, the Bank of America has a partnership with VISA and American Express.
Life-Stage Based Services
The second service group is designed based on the life-stage of its customers. There is a mortgage plan for a customer for buying a house, and a loan plan for purchasing a vehicle. If a customer has a child and wants to prepare for his/her education, the Bank of America provides an education saving plan. For those who want to start considering their retirements, it offers several retirement plans, such as reverse mortgage, 401Kplan, Annuities, Individual Retirement Arrangement (IRA). Most of the products in this group are offered by BAC, except for investment products and insurance.
The investment products, IRA and 401K plan for example, are offered by the Bank of America Investment Services, Inc. The Bank of America Investment Services, Inc. is a subsidiary of BAC, which assumes investment and premier banking responsibilities (as of December 7, 2009, it seems that products of Banc of America Investment Services are offered by Merrill Lynch).
A couple of types of insurance are offered by several agencies depending on the customers’ needs, such as life insurance, auto insurance, and home insurance. Life insurance is provided by three agents. For simplified term life insurance, Great-West Life & Annuity Insurance Company offers it to non-New York state residents, and First Great-West & Annuity Insurance Company provides it to the residents of the New York state. Term life insurance is offered by AMPAC Insurance Marketing, Inc. , and Auto Insurance is available at GEICO. If a customer needs to buy home insurance, s/he can contract with the Bank of America and the Banc of America Insurance Service, Inc.
As a subsidiary of the Bank of America, the Bank of America Insurance Service, Inc. belongs to the non-banking industry. AMPAC Insurance Marketing, Inc. and the Bank of America tied up their partnership. In August 2007, Warren Buffet, who is the owner of the parent company of GEICO (Berkshire Hathaway), bought approximately 5% of the Bank of America’s shares.
From the above-mentioned points, it is observed that the Bank of America creates strong relationships with those companies through partnership, underwriting preferred shares, or letting others to be its shareholders.
In addition, in the insurance area, it is observed that BAC offers Auto insurance through GEICO, but not by its own subsidiary. Since GEICO is the third largest insurer for the US autos, it implies that the Bank of America uses GEICO’s brand name for a fulfillment of its product line-up.
Monetary-Status Based Services
The third group of services is based on monetary status. One example is the wealth management. Although investment and gift fund services are provided by subsidiaries of the Bank of America, such as the Banc of America Investment Services, Inc. and Columbia Management Group , the wealth management advisory is mainly implemented by U. S. Trust, which is another subsidiary of the Bank of America. This division of roles shows that the Bank of America aims each subsidiary to focus on one role in the Bank of America corporation group. Other than the wealth management, the Bank of America offers the refinance program for its customers who have a hardship to repay their mortgages.
Specific Services for the Certain Occupations
The final group of personal services are distinctive services by the occupations. BAC offers specific account services for students and military officers.
Corporate Banking
There are two segments of corporate banking, such as small businesses and large corporations/institutions.
For small business, BAC offers almost all of the services, such as merchant card processing, online payroll, invoicing, tax services, and lending money. For this segment, BAC has a partnership with VISA and MasterCard, but not with American Express, in terms of corporate card service.
For large corporations and institutions, BAC offers similar corporate card services as the small business obtains. However, the services for this segment are divided by Merrill Lynch and other subsidiaries that depend on the clients’ industry. For example, Merrill Lynch solely provides its services to accounting firms, law firms, and Security Alarm industries. The Bank of America Public Capital Corp offers services to the non-profit organizations. Although the Banc of America Securities LLC. provides its services to some industries solely, such as sport and natural resources, it also deliver some services instead of Merrill Lynch with other industries.
This division of roles between three subsidiaries implies that BAC focuses on shaping its business by the resource-based perspective in terms of corporate banking service.
Examining the customer groups through Porter’s five forces model there are high levels of initial buyer power as there are many different firms offering similar services to all clients. This power does shift once the buyer has made an initial decision as the cost of switching to another firm, both monetary and non-monetary, can be significant.
2d - Mapping of Relevant Strategic Groups (by Tony von Richter)
Citigroup
Citigroup offers services similar to Bank of America and competes with them in all of their business segments. The company recently restructured their operations into two major operating groups: Citicorp and Citi Holdings. Citicorp focuses on banking services for business and consumers. Citi Holdings focuses on mortgages, asset management, and the assets covered under the company’s loss-sharing agreement with the US government. In 2008 Citi posted losses of 27.7 billion.
JP Morgan Chase
JP Morgan Chase offers products in the same segments as Bank of America, however the company is focused more towards the investment, card services, and retail banking sectors as they account for 72% of the company’s revenues. In 2008 the company reported a profit of $6.5 billion. The company expanded on both the retail and investment sides of the financial industry with its acquisitions of Bear Sterns and Washington Mutual.
Wells Fargo
Operating in 39 states Wells Fargo earned a $2.7 billion profit in 2008 and managed to increase revenues by 6 per cent. The company completed a takeover of Wachovia on Dec. 31, 2008. Primarily focused on retail banking (what the company refers to as ‘Community Banking’ resulted in 32 per cent of the company’s earnings (not including Wachovia’s earnings). The next biggest portions of the company’s business are the specialized lending (student loans, credit cards, etc.) and home mortgage segments each earning 19% of the firm’s revenue.
3a - Generic Strategic Orientation (Jake Saunders)
BAC is currently pursuing a broad differentiation strategy, as they are currently a full-service provider in the financial services. At the heart of BAC’s strategy is the ambition to become the number one, largest bank within its domestic market; it pursues this goal through making both key acquisitions to expand its market and organic growth within its segments.
The company has made several key acquisitions within the past five years while following a market development approach to growing their operations. Acquisitions of MBNA in 2005, a credit card giant, allowed the company to become a leading credit card issuer as they penetrated this relatively new market; this division now consists of Bank of America’s Card Services. In 2008, Countrywide Financial was acquired for approximately 4.1 billion and this allowed the company to buy a substantial market share of the home mortgage industry, where BAC previously had little presence; Countrywide Financial has since become Bank of America Home Loans. Finally, Merrill Lynch’s acquisition was finalized in early 2009 as this was BAC’s shift to strengthen their investment banking and wealth management divisions, which had previously been downsizing prior to the acquisition. Merrill Lynch allowed the company to officially become the largest brokerage in the world with more than 20,000 advisors and 2.5 trillion in client assets.
These acquisitions allowed BAC to expand their market and grow into new segments where they did not competitively participate and where their presence was weak. In the case of Merrill Lynch and Countrywide, both of these companies were near bankruptcy and BAC likely saw this as an opportunity to acquire huge market share in both industries at a significant discount, due to the influence the financial crisis had had on both firm’s market value.
The acquisition of Merrill Lynch came at a significant cost to BAC as the extent of the 2008 losses reported by Merrill Lynch nearly destroyed the deal; CEO Ken Lewis suggested before congress that once he had expressed his interest in backing out of the deal, he was pressured into completing the acquisition of Merrill Lynch or faced losing his job and BAC’s relationship would be damaged with regulators, forcing the deal to go through to the anger of many shareholders. Merrill Lynch reported a fourth quarter loss of $21.5 billion, which was eventually absorbed by BAC once the acquisition was concluded on January 1st, 2009. From such losses, and among other contributing factors occurring before this acquisition, this left BAC in a liquidity crisis and desperate for added capital strength. Although the company was actively purchasing companies in 2008 and on into 2009 suggesting that they were in a superior financial position, they were making decisions internally to raise their capital strength as they were struggling and highly volatile.
During 2008, in order to cut costs and preserve capital, the company cut their dividend to a penny, which had increased each year since 1977; other cost cutting initiatives to reduce preventable spending included no bonuses or incentive compensation for the year to members of the banks executive management. To raise capital for the company, they issued $10 billion worth of common stock in the secondary market in order to increase liquidity. On top of all of this, the company received $20 billion from TARP funds in 2009 to supposedly aid in closing the deal with Merrill Lynch, on top of the $25 billion that had already been received from TARP. The company described this as necessary for the bank to maintain their capital strength and stability throughout the crisis. The company seems to be doing all that is possible to maintain the highest levels of capital achievable within the company through these though times.
When the characteristics of their operating strategy are dissected, BAC is making numerous movements in response to the financial crisis towards realizing their goal of becoming the largest bank within their domestic market. To begin, in their 2008 annual statements, they have realized that they cannot so heavily depend on complex mathematical models for assessing risk, as the company’s CEO expresses taking more of a “commonsense” approach and understanding of economic fundamentals is necessary. These new assessments of risk factors, such as credit worthiness, portfolio structure, and the like, includes the use of new tools and approaches to managing risk more effectively, and will likely be necessary to ensure stability going forward. BAC has expressed their disinterest in future excessive use of derivatives and complex unregulated financial instruments, which in part played a role in causing the financial crisis; simple, transparent financial products to meet customers’ current needs shall be one of the main focuses of the company going forward.
BAC has built their business on the basis of “diversity creates strength”. The business believes that the more growth opportunities that they can pursue in coordination to each other, the more likely they will be in a position to achieve their goals. The company feels that if they are able to diversity their businesses, revenue streams, risks, ideas, perspectives, and people, this will allow them to become the leading provider of financial services in the United States. Through this diversification strategy of their operations, primarily being accomplished through their acquisition strategy, it allows them to become a full service provider of financial services, providing a high degree of convenience and increased simplicity for the consumer.
Another important aspect of BAC’s operational strategy consists of their public relations efforts and charitable generosity initiatives. BAC’s created an environmental initiative that encompasses $20 billion in charitable donations over 10 years to address global climate change. This initiative includes creating environmental opportunities and is part of a larger organizational commitment to supporting a healthy economy in the United States, creating access to greater economic and social opportunities for people and business across the country as the company feels that the long-term sustainability of the company is based on the health and wellbeing of American communities. The Neighborhood Excellence Initiative is a grant program the banks signature philanthropic program while it rewards community -based organizations, local heroes and student leaders who work to improve their communities. The program focuses on areas such as: education, community development/ neighborhood preservation, arts and culture, and health and human services. The majority of their charitable contributions are based on the theme of developing “healthy communities”, as the bank feels that this principle will aid in the banks prosperity into the future.
3b - Competitive Advantages and Disadvantages (by Prashant Pradhan)
Two central questions underlie the competitive position. The first is the attractiveness of industries for long-term profitability and the factors that determine it. The second central question in competitive position is the determinants of relative competitive position with in an industry. Neither point mentioned above is sufficient by itself to establish a competitive advantage. Both industry attractiveness and competitive position can be shaped by a firm by choosing a competitive strategy both challenging and exciting. One of the factors on which competitive advantage is dependent is industry attractiveness, however this is partly a reflection of factors over which a firm has little influence. However, choice of sound competitive strategy has considerable power to make an industry more or less attractive. At the same time a firm can clearly improve or erode its position within an industry through its choice of strategy. Competitive strategy not only responds to the environment but also attempts to shape that environment in a firm's favour.
The firm’s competitive advantage arises from the industry that the firm operates in. In any industry, whether it is domestic or international or produces a product or a service, the rules of competition are embodied in five competitive forces: the bargaining power of buyers, the bargaining power of suppliers, the entry of new competitors, the threat of substitutes and the rivalry among existing competitors. The collective strength of these five competitive forces determines the ability of the firms in an industry to earn on average rates of return on investment in excess of cost of capital. If the five competitive forces and their structural determinants were solely a function of intrinsic industry characteristics, then competitive strategy would rest heavily on picking the right industry and understanding the five forces better than competitors. But while these are surely important tasks for any firm and are the essence of competitive strategy in some industries, a firm is usually not a prisoner of its industry's structure. Firms, through their strategies can influence the five forces. If a firm can shape structure, it can fundamentally change an industry's attractiveness for better or for worse. Many successful competitors have shifted the rules of competition in this way. As such, while analyzing the competitive advantage of BAC, it will have to be looked at from the prospective of how attractive the industry is as well. In terms of new entrants, doing business in the banking and finance sector entails huge capital investments as well as compliance with number of rules and regulation both in state and federal level. As such an average person can't come along and start up a bank. However different banks within a banking industry are categorized based on the different capital structure and the area of coverage. These banks have the ability to enter into a sector that they were not currently catering to by increasing the level of capital or fulfilling some regulatory requirement. As such, potential threats arise from existing banks that are not catering to that segment. For example an insurance company can start offering mortgage and loan services or a regional bank can expand and be a national bank thereby competing with the existing national banks.
Power of Suppliers
Banks are involved in a service industry, as such the question of raw material supplier does not arise. The ability of a bank to service its customer is entirely dependent on its people. Therefore power of supplier can be looked at from the perspective of its employees. As such there is threat of employees being lured away by its competitors. At the same time due to the recent sub-prime mortgage crisis the issue of compensation has become a very sensitive issue. As such there is the ever-looming threat that good employees may be lured away by competitors by providing better incentives. Another supplier to banks are the suppliers of capital. If the bank is stable and under normal circumstances, the suppliers of capital might not pose a big threat, however under uncertain circumstances like the recent sub-prime mortgage crisis, which exposes the vulnerability of the bank, the suppliers of the capital may try to get out of the market.
Power of Buyers
The customers of a bank have the option to choose from so many different banks which means that the power of buyer is relatively high. However one factor that prevents investors from switching from one bank to another is relatively high switching cost. If a person has a mortgage, car loan, credit card, line of credit etc. with one particular bank, it can be extremely hard for that person to switch to another bank given the inconvenience of switching the products from one bank to another. Banks try to lure in customers by reducing the cost of changing banks but are not very successful. On the other hand, large corporate clients have strong bargaining power. Financial institutions offer competitive interest rates, exchange rates and better service to maintain corporate clients.
Availability of Substitutes
Even though over 130 banks have failed in the past year , there are still many substitutes in the banking industry. Although banks offer different services but since the services offered by the banks are standardized in nature, the customer has the option to choose from a wide array of options. At the same time, these days non-banking financial services are offering similar services like that offered by bank which increases the number of substitutes. For example when one goes to buy a car, the companies are offering 0% financing.
Competitive Rivalry
The banking industry is highly competitive. As mentioned above the number of substitutes in the banking industry is high and at the same time the services offered by different banks are very standardized as such they try to differentiate by offering lower financing, preferred rates and investment services.
Having analyzed the competitive attractiveness of the banking industry, the competitive advantages from the perspective of BAC are outlined below.
Size
BAC is one of the largest banks in the world and in the USA. It is the nation’s largest consumer bank. Its geographic reach is coast-to-coast, covering over 32 states. They currently have a customer base of over 53 million and over 18,254 ATM machines.
Economies of Scope
Given the size of BAC, economies of scope automatically arises as by having so many branches BAC can offer different services to its customers as such resulting in the economies of scope.
Too Big to Fail
As mentioned earlier, BAC is one of the biggest Bank in America and it has a very wide coverage the failure of which could have a catastrophic impact on the financial systems of America. Therefore they are considered as "too big to fail" by the United States Government. As such this can be one competitive advantage of BAC because if they are considered too big to fail, the Government will ensure its continuity.
Brand Value
BAC has a rich history of over 78 years of operation. Given its wide coverage in America as well as its presence in different parts of the world, BAC has an established brand value. Even though BAC had to resort to TARP funds to maintain a sound capital, despite severe difficulty in the financial market as a result of credit squeeze, BAC was able to generate profit though at a reduced level at the end of fiscal year 2008.
In terms of competitive disadvantage, the size of BAC can also be a competitive disadvantage because given the size of BAC it is difficult for BAC adapt to changing situations quick at the same time it is difficult for BAC to tailor to local needs. Another competitive disadvantage of BAC is the existence of TARP funds in its capital structure. During the recent sub-prime mortgage crisis, BAC had resorted to TARP funds to maintain its capital level which was provided under some strict conditions that BAC are required to comply with. For example some conditions were required to be fulfilled before paying bonus to its executives. As such, having TARP funds in its capital structure limits the flexibility with which the Bank of America can operate. This can have an adverse impact because important people can leave BAC and join other organizations. The Bank of America will also have to work on improving its current financial position. In 2008, BAC earned $4.01 billion, down from $14.98 billion in 2007. Revenue (on a fully taxable-equivalent basis) rose 8 percent to $73.98 billion from $68.58 billion in 2007, from organic growth and the addition of U.S. Trust, LaSalle and Countrywide. Return on average common shareholders’ equity fell to 1.80 percent from 11.08 percent. Provision expense rose $18.44 billion to $26.83 billion, and nonperforming assets and net charge-off ratios rose to 1.96 percent and 1.79 percent, respectively.
3c - Strategic Weaknesses at the Business and Functional Levels (by Prashant Pradhan)
Effective January 1, 2009 with the acquisition of Merrill Lynch BAC changed the basis of presentation from three segments to six segments- deposits, global card services, home loans and insurance, global banking, global markets and Global Wealth and Investment Management with the remaining operations recorded as all other. The former Global Consumer and Small Business Banking now is reflected in three separate business segments: Deposits, Global Card Services and Home Loans and Insurance. In order to better coordinate consumer payment business BAC consolidated all consumer and small business card products into Global Card Services; therefore debit card has moved from deposits to card services. The former Global Corporate and Investment Banking now is divided into Global Banking and Global Markets. As such while analyzing the strategic weaknesses at the business and functional level it has been looked at from the six segments or area of business of BAC.
Deposits
Deposits includes the consumer deposit activities, which consist of a comprehensive range of products provided to consumers and small businesses. At the same time deposits also includes student lending results and the effect of asset liability management activities. In the USA, BAC caters to approximately 53 million consumer and small business relationships through a franchise that stretches through 32 states and the District of Columbia utilizing network of 6,008 banking centers, 18,254 domestic branded ATMs, and telephone and Internet channels. BAC’s deposit products include traditional savings accounts, money market savings accounts, certificate of deposits and non-interest and interest-bearing checking accounts. Deposit products provide a relatively stable source of funding and liquidity. They earn net interest spread revenues from investing this liquidity in earning assets through extending lending facility to client and asset liability management activities. The revenue is allocated to the deposit products using funds transfer pricing process which takes into account the interest rates and maturity characteristics of the deposits. Deposits also generate fees such as account service fees, non-sufficient fund fees, overdraft charges and ATM fees.
During the third quarter of 2009, BAC announced changes to its overdraft fee policies intended to help customers limit overdraft fees. These changes will negatively impact net revenue beginning in the fourth quarter of 2009. In addition, in the fourth quarter of 2009, the Federal Reserve is expected to issue the final Electronic Funds Transfer Act (i.e., Regulation E), which could
