January 14, 2013 - If You Want Returns from Banks, Skip the Deposit Slip
You have probably noticed that you are not getting much interest on the money in the bank these days. With the Federal Reserve keeping interest rates at historic lows, most banks pay such little interest that they might as well pay none at all. Investors who want returns that outpace inflation must look in other areas.
The economy is on a slow recovery. Technically, we are not in a recession any longer; but with so many people still out of work and others under employed, it feels a lot like one. Congress hit the fiscal cliff and at the last minute kicked the proverbial can down the road. There were some permanent fixes in the package, but many of the hard decisions were put off. It can be very understandable if business owners are less than excited about expanding businesses in an economic environment that keeps them guessing about what is going to happen.
Some economists have suggested the collective tax increases enacted by the legislation will slow economic growth around 1%. Estimates for 2012 place GDP growth near 2% a year -- well below the 3.2% a year average growth. Some of the effects may be felt by a lack of growth we would have otherwise seen, but the businesses realize there is still an economic headwind.
One sector that has been performing better than average over the few months and year is the financial sector. Finance stocks took a big hit in the financial crisis but are now seeing gains. Many of the big banks like Citigroup ( C ), Goldman Sacks (GS), Bank of America (BAC), JP Morgan Chase (JPM), USB and Capital One Financial (COF) report soon. These banks may set the pace for other companies reporting earnings.
Bank of America is the second largest US bank with assets of $2.2 trillion. There are 282,000 employees, 17,000 ATMs, and over 5,500 branch offices in 36 states. The company has a market capitalization of $129 billion. The stock is trading near $12 a share. The subprime financial crisis almost took the bank under with the stock falling as low as $2.53 a share in the aftermath (in comparison, it also traded as high as $52 in 2007). As one of the "too big to fail" banks it had federal assistance and also bought out or rescued Countrywide Financial and Merrill Lynch during the crisis. The bank exited the mortgage loan business in 2011 and just settled a $3.6 billion lawsuit with Fannie Mae. S&P recently upgraded the company from a 2 STARS sell to a 3 STARS hold.
Long term, the earnings picture is improving at Bank of America. In 2009, the company lost $0.29 per share and in 2010 the company lost $0.37 cents per share. In 2011 the company made $0.01 per share and in 2012 expectations are for earnings of $0.40 per share. These earnings are improving, but are very mild to, say, 2007's $3.30 a share in earnings. Expectations for the fourth quarter due out January 17 are for $0.01 per share and in the prior year it made $0.15 per share.
Analysts expect profits for the major banks to grow 32% in 2013 after 13% growth in 2012 with revenues mostly flat, as non-interest expenses fall such as write-offs fall. There are risks with a precarious situation in Europe, slow growth internationally and the already-mentioned fiscal cliff in the USA. One might not expect huge appreciation and might also want to take a hedge in the position.
Take a look at a covered call on Bank of America. With the stock trading near $12, the August 2013 $12 strike is available for a 10.80 net debit. This would give the covered call an 11% assigned return, about 10% of downside protection, and an annualized return rate of 18% (for comparison purposes only). Putting your money in a savings account at the bank will get you almost nothing in interest, while putting money into a covered call trade like this could net an annualized 18% return (for comparison purposes only). A covered call has a higher return, but also higher risk as the stock could fall and you could lose a portion of your principle.
Some investors might still be skittish with banks after the crisis and that is understandable. Banks have been doing well in spite of the various headwinds in the industry. A covered call can put an investor in the bank, but also give downside protection and returns if the market stays flat. The higher returns a covered call offers could make it an attractive place to park cash for a while. Money in a bank shrinks each year with inflation, so weigh the risks for your own portfolio with your financial advisor.