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July 23, 2021 | Many of the readers of The Institutional Risk Analyst ask why we hate Bank of America (NYSE:BAC) CEO Brian Moynihan so. In fact, we love Brian as much as we adore all bank lawyers. Our criticism arises because the financial performance of the depository founded by A. P. Giannini as the Bank of Italy in 1904 is truly awful, as we discuss below. BAC is the worst performing bank in the top-five US commercial banks and often underperforms the average for Peer Group 1. We don’t make up BAC’s numbers. IOHO, Moynihan and the entire board of directors of BAC ought to be walked out of the building.
The first measure to examine is operating efficiency, an area where BAC has consistently underperformed its peers. In the most recent Q2 2021 financials, BAC reported an efficiency ratio (Overhead Expenses / Net Interest Income + Non-Interest Income) of almost 70% or roughly ten points above JPMorgan (NYSE:JPM). The average for Peer Group 1 in Q1 2021 was 59%, according to the FFIEC.
Source: FFIEC, EDGAR, Q2 2021 Estimate for Peer Group 1
Notice in the chart above that even in a quarter where financials were generally improving across the industry, BAC managed to underperform its large bank peers including Wells Fargo & Co (NYSE:WFC), which remains in regulatory purgatory and operates under an asset cap. Note too that Citigroup (NYSE:C) greatly improved its operating performance in Q2 2021.
The next measure to consider is asset returns. As we have noted in the past, BAC generates less income per dollar of assets than its large bank peers. The historical performance data from the FFIEC is shown in the chart below. In Q2 2021, BAC managed to report a return on average assets of 1.18% — including $3.4 billion in provisions expense from 2020 that was reversed back into income.
Of note, the BAC’s loan portfolio has fallen almost 8% since Q2 2020, even as total assets have swollen due to QE by the Fed. Indeed, BAC’s securities holdings are bigger than the bank’s entire loan portfolio.
The basic problem at BAC is asset returns. Since the management team under CEO Moynihan has made avoiding risk their chief priority, this also means that the $3 trillion asset depository also misses a lot of opportunity for profit and earnings. Notice, for example, that JPM at $3.6 trillion in assets generated almost a third more revenue at $32 billion in Q2 2021 vs BAC at $21 billion. JPM is 20% larger in terms of assets, but generates a third more earnings.
When we consider the reasons for BAC underperformance, the gross spread on the bank’s loan book is one of the first factors to consider. The chart below shows the historical spread information compiled by the FFIEC. Note that BAC’s gross spread on total loans and leases is nearly a full point below JPM and is also significantly lower than the average for Peer Group 1, which includes the top 125 banks in the US above $10 billion in assets.
Indeed, if you consider that BAC’s gross spread on loans and leases is below that of the constrained WFC, the picture takes on an even more dramatic coloration. The only thing that saves BAC, to an extent, is the fact that the bank’s cost of funds is extremely low. The chart below shows the historical interest expense for the top five banks and Peer Group 1.
In the most recent quarter, BAC’s cost of funds fell to just $1.1 billion vs $1.6 billion in Q2 2020, yet the bank’s net interest income was down $400 million YOY. Part of this is caused by the relentless downward pressure on yields due to the Federal Open Market Committee’s policy of massive asset purchases or QE. But the other factor behind the bank’s poor financial performance comes from asset returns, as shown in the table below from BAC’s Q2 2021 earnings release.
Another factor tending to hurt BAC’s overall performance is credit loss, where the bank is right behind JPM in terms of net charge offs. Indeed, BAC’s loss rate is 2x the average for Peer Group 1, yet the bank does not have the income to compete with the House of Morgan when it comes to the bottom line. How can Brian Moynihan prattle on about managing risk and sustainable growth when his loss rate is not sized with his asset returns?
At the end of the day, BAC is a bank that has been drifting since the 2012 National Mortgage Settlement, a near-death experience that saw the parent company planning for a voluntary Chapter 11 bankruptcy filing to cleanse the massive liabilities acquired from the purchase of subprime lender Countywide Financial. Since that time, BAC has lagged the group in terms of asset and equity returns, the legacy of an entrenched management team that has made risk avoidance the priority but has not grown the business.
Since the start of 2021, BAC and other names have experienced a considerable rally as investors anticipated the return of billions of dollars in loan loss provisions back into income. The earnings of Q1 2021 may well be the peak for the year, as illustrated by the decline in BAC’s income even despite the earnings release.
By no coincidence, the equity market valuations for the top banks have been trending lower since the end of the first quarter of this year. Notice in the chart below that of the five top banks, WFC has been the best performing stock in 2021 followed by BAC, a cautionary point that suggests that quality of operations is not always the best determinant of market performance.
Source: Google Finance
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