Bank of Americas First-Quarter Earnings Were Better, but Still Far From Good

By Markets Fool.com

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Bank of America's headquarters in Charlotte, North Carolina. Source: iStock/Thinkstock.

You'll have to excuse me for being somewhat of apessimist on the subject, but I'm struggling to get excited about Bank of America's performance in the latest quarter.

Yes, it earned $3.4 billion. And yes, that was one of its best quarterly performances since the onset of the financial crisis. But compared to industry leaders like Wells Fargo and US Bancorp, it's almost as if Bank of America is in an entirely different league -- and I don't mean that as a compliment.

The good news: expenses are declining
To be fair, Bank of America is making progress. This is particularly clear when you look at its operating expenses, which have been one of the main reasons the bank has trailed its better-healed rivals (in terms of profitability) since 2008.

After excluding legal costs, its first-quarter operating expenses, which include employee bonuses for the prior year and are thus higher than any other quarter, have dropped by 18% since the first quarter of 2012. The improvement is even more dramatic if you include litigation expenses. In the first three months of this year, Bank of America incurred $400 million in legal costs compared to $6 billion in the same period last year.

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But even with this progress, Bank of America still allocates too much of its net revenue to operating expenses as opposed to profit. Costs consumed 74% of its top line in the first quarter as opposed to 55% and 59% at US Bancorp and Wells Fargo, respectively.

The bad news: expenses aren't the only problem
In addition to its bloated expense base, Bank of America earns less revenue on a relative basis than its peers do. In the first quarter, the Charlotte-based bank generated $21.2 billion in net revenue from $2.1 trillion in average assets. That equates to an annualized yield of 3.99%. Meanwhile, Wells Fargo earned $21.3 billion in revenue from only $1.7 trillion in average assets, equating to an annualized yield of 4.97%.

What's going on here? In the first case, Bank of America carries more deadweight on its balance sheet than Wells Fargo does. Whereas 90% of the latter's assets earn interest, only 84% of the former's do. This can be traced to a number of things, but foremost among them is the fact that, on a proportional basis, Bank of America's balance sheet is weighed down by more than twice as much goodwill -- an intangible asset emitted from acquisitions -- as Wells Fargo's.

Secondly, Bank of America's net interest margin -- i.e., net interest income as a percent of interest-earning assets -- is only 2.14% versus Wells Fargo's 2.93%. This follows from the fact that Bank of America's trading and investment banking operations require it to stay unusually liquid. While Wells Fargo can allocate a larger share of its assets to higher-yielding but less liquid loans, Bank of America is stuck holding more lower-yielding but highly marketable investment securities.

It's also worth noting that Wells Fargo's loans simply yield more than Bank of America's do. And not just a little bit more. Throughout the first quarter, Wells Fargo's loan portfolio yielded 4.19% compared to Bank of America's 3.75%.

All of this would be much ado about nothing if Bank of America made up for the difference with noninterest income from its investment banking and trading operations. But it doesn't. You can infer this from the fact that Wells Fargo's noninterest income equates to 2.40% of its average assets on an annual basis versus 2.21% for Bank of America.

The net result is that Bank of America continues to struggle virtually across the board. This doesn't mean it will never be able to compete on a level playing field with the likes of Wells Fargo and US Bancorp. But it does mean that the nation's second largest bank by assets still has a long way to go before it's even in the same ballpark.

The article Bank of Americas First-Quarter Earnings Were Better, but Still Far From Good originally appeared on Fool.com.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America and Wells Fargo. 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.