Breaking Down Bank of America's Bottom-Line Woes
Something's obviously very wrong with Bank of America's bottom line. This is a bank that was earning high-teens -- if not low-twenties -- returns on equity prior to the financial crisis. Now just eeking out 5% has become the new normal.
For a Bank of America bear, it may seem easy to point a finger at the business itself and say that it's slipping. That is, customers don't want to bank with B of A, it can't get any momentum behind its revenue, etc. But I'm not convinced that's the case.
It's typical to look at the returns from a bank on the basis of net income divided by total assets (return on assets). What's less often looked at is the revenue produced by a bank's assets.
Bank of America's total pre-provision revenue as a percentage of tangible assets was 4.5% based on annualized first quarter revenue. That's below heady years like 2009 (5.6%) and 2003 (5.5%), but it's only slightly below the median of all years between 2002 and Q1 2013.
There's still some room for concern over B of A's top line. And by looking at the changing asset mix on the balance sheet from pre-crisis to post-crisis -- more cash, lower loan balances as a percentage of assets -- it appears there's room for the bank to shift gears and generate more revenue from its asset base.
But when we consider the fact that revenue production doesn't appear to be grossly out of whack with the past, it becomes even more evident that this is an expense issue, not a top-line issue. B of A's 2012 efficiency ratio of over 80 underscores this.
To me, this suggests Brian Moynihan's approach with Project New BAC is the right one -- that is, go after unnecessary costs. However, it also suggests this won't be an overnight process.
The bank's Consumer Real Estate Services segment is a good example of where expenses are way off track. During the first quarter, the segment produced $2.3 billion in pre-provision revenue and had $4.1 billion in overhead. This is obviously not a recipe for success. Break down that segment further though and you'll find that more than $3 billion of the segment's costs come from the Legacy Asset & Servicing subsegment, which includes a lot of the cruddy loans that B of A is trying to run off or get rid of. That loan portfolio shrunk 21% year over year in the first quarter and the number of employees in the segment likewise fell.
In other words, progress is taking place. It may be somewhat in the tradition of "two steps forward and one step back" and be clouded at times by ongoing legal hazmat cleanup. But that may also mean that as short-term-focused market participants pull their hair out over one quarter's numbers, sneaky improvements are working in the favor of longer-term investors.
Time to buy BAC?
Bank of America's stock doubled in 2012. Is there more yet to come? With significant challenges still ahead, it's critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool's premium research report on B of A, analysts Anand Chokkavelu, CFA, and Matt Koppenheffer, Financials bureau chief, lift the veil on the bank's operations, including detailing three reasons to buy and three reasons to sell. Click here now to claim your copy.
The article Breaking Down Bank of America's Bottom-Line Woes originally appeared on Fool.com.Matt Koppenheffer owns shares of Bank of America. The Motley Fool owns shares of Bank of America. 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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