Bank of America Corp and Citigroup: Why Investors Should Be Optimistic

If you think the banking industry will never recover from turmoil that entangled it following the financial crisis, recent evidence reveals it's time to think again.

The troubling market
Many have wondered if the banks will ever be able to truly return to the remarkable profitability that once characterized them in the years before the Great Recession.

In March, we learned Bank of America would shell out $6.3 billion to settle its mortgage securities lawsuit. At the end of April, Bank of America revealed it would have to resubmit its plans to the Federal Reserve to raise its dividend because it incorrectly accounted for bonds it acquired through Merrill Lynch. 


And while it's not directly related to the financial crisis, the ongoing turmoil surrounding Citigroup continues, as just this week investors learned Mexican authorities would seek to arrest executives of its Banamex subsidiary for fraud. And remember, this crime resulted in Citigroup having to lower its 2013 pre-tax income by $360 million. 

Now, as we are more than five years removed the depths of the financial crisis, it's easy to think things will simply never get better for Bank of America, Citigroup, or the other banks. But taking a step backwards to look at the big picture shows something we must be reminded of.

The truth
Every quarter, the Federal Deposit Insurance Corporation (FDIC) provides a helpful glimpse into the health of the entire banking industry by releasing the summary of results for all the banks it insures. And the most recent release -- looking at the last three months and the full year of 2013 -- was no exception.

When it came to bottom-line results, one of the most eye-opening things was that banks have actually fully rebounded to pre-crisis levels, as the total net income of banks stood at an astonishing $154 billion in 2013: 


Source: FDIC.

Of course, the rebound in net income is both surprising and encouraging, but it's important to remember it's just one raw number. And a glimpse into the profitability ratios of the banks reveals something even more surprising:


Source: FDIC.

As you can see, despite the record levels of total net income, it turns out the biggest banks are still significantly far from their former levels of profitability, as measured by the return they provide on assets and equity.

There are two ways to take this reality. The less optimistic approach would say this is all the evidence needed to show banks will never return to their former ways. But the second would suggest the continued improvement over the last five years suggests the banks are headed in the right direction.

And I'd like to take the latter.

Remember most banks make roughly half -- 46% for Bank of America and 58% for Citigroup -- of their money from the difference between what they pay on deposits versus what they collect on loans, known as net interest margin. With interest rates still incredibly low, as rates rise, banks will continue to see their margins expand, so that's one reason for confidence.

This chart is also evidence that while the improvement hasn't fully arrived yet, the banks continue to progress in a slow but steady manner. Great troubles characterized them in 2008 and 2009, but with every passing quarter, we can have more confidence the rebound is progressing.

What's not shown by only looking at ROE and ROA is the potential for more dividends. As banks like Bank of America and Citigroup retain more earnings, capital levels will continue to rise. While regulators are holding back the banks' abilities to payout a substantial portion of earnings (the Fed currently doesn't like banks paying more than 30% of its earnings in dividends), I believe capital levels will get so healthy in the coming years that the regulators will allow that percentage to creep higher.

The recovery for the biggest banks hasn't been quick, and it still has a ways to go, but it is under way, and investors should have great confidence in that.

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The article Bank of America Corp and Citigroup: Why Investors Should Be Optimistic originally appeared on Fool.com.

Patrick Morris owns shares of Bank of America. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America and Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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