This Is Bank of Americas Biggest Challenge

By Markets Fool.com

In the third-to-last paragraph of Brian Moynihan's 2014 shareholder letter, the Bank of America CEO rolled out the bank's current PR campaign, which emphasizes the importance of "delivering responsible growth." He doubled down on the message in his 2015 letter, which was released three months ago and dedicated to flushing out the contours of this point.

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"When we look at where we stand today, our company is stronger, simpler, and better positioned to deliver long-term value to our shareholders, thanks to the straightforward way in which we serve our customers and clients," Moynihan wrote. "The path forward is clearly one of responsible growth."

The 56-year-old executive then spent the next seven pages detailing the four pillars of Bank of America's strategy to grow responsibly. These have since been encapsulated in a graphic that's often included in the bank's presentations to analysts:

Image source: Bank of America.

Every time I come across this graphic, I'm reminded of the line from Shakespeare's Hamlet, "The lady doth protest too much, methinks." Shouldn't investors today be able to assume that Bank of America is dedicated to growing responsibly? And if so, then why does the bank feel the need to constantly remind us that it's focused on doing so?

The easy answer is that acting responsibly represents a departure from Bank of America's former strategy to grow at any cost. Before the financial crisis, the North Carolina-based bank thought nothing of acquiring companies at exorbitant multiples of book value and approving credit cards for anyone capable of applying for one. This "bigger is better" mind-set explains why Bank of America nearly drowned under a sea of toxic loans and legal liabilities in the wake of the crisis.

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But there's a second and, I believe, more pressing reason that Bank of America feels the need to constantly reaffirm to investors and analysts that it's seen the light in terms of responsible growth. It's my opinion that the bank's executives have finally come to terms with the fact that growing responsibly is hard, particularly under the specific post-crisis regulatory constraints that the $2.2 trillion bank faces.

The most onerous constraint concerns capital. As a global systematically important bank, Bank of America can't use as much leverage as its smaller and simpler peers. This is because it has to hold more capital relative to its assets than virtually every other bank in the United States, with the exceptions of JPMorgan Chase and Citigroup. This weighs on Bank of America's profitability, which in turn throttles the speed that its retained earnings accumulate and compound.

A second and similarly onerous constraint concerns liquidity, which is just a fancy way to say that a larger percentage (compared to most other banks) of Bank of America's assets must consist of cash or low-yielding assets, such as government bonds. This drives down its pre-tax net interest income and, as such, its after-tax earnings. The so-called liquidity coverage ratio is to blame, as it requires banks with Wall Street operations to hold more liquidity than banks that focus on loans and deposits.

Taken together, Bank of America is fighting an uphill battle when it comes to growth. And I believe this is the reason Moynihan feels the need to constantly emphasize acting responsibly.

Moynihan knows that growing a bank irresponsibly is easy -- all you have to do is lower your credit standards and underwrite more loans. That's what Bank of America did in the decade leading up to the 2008 crisis. But with regulators monitoring Bank of America's every move, and with its performance during the crisis fresh on its executives' minds, this is no longer a viable option.

The key is to make sure that the market understands this, and to thereby calibrate investors' expectations appropriately, which is exactly what Bank of America is doing now that it's put the worst of the crisis behind it. Indeed, it's no coincidence that nation's second-biggest bank by assets doubled down on its focus on responsible growth in the same year that it seems to have turned the corneron the worst economic downturn since the Great Depression.

The article This Is Bank of Americas Biggest Challenge originally appeared on Fool.com.

John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool recommends 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.