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Summary

  • Bank of America's lower long-term debt balance is not the only way the bank can save money.
  • A better credit rating means the bank's debt churn can be refinanced at lower rates.
  • A look at the debt pipeline reveals more cost cuts are on the way.

In my last article about Bank of America (NYSE:BAC) I dug into the lower costs that have been afforded to the bank through a larger non-interest bearing deposit balance. At this point, this transition has put the bank on par with the cost of deposits over at Wells Fargo (NYSE:WFC), a huge step in the right direction if we can agree that Wells Fargo's superior cost advantage can be used to compare the most ideal position a mega bank can be in. With this in mind, I finished the article by comparing the total percentage paid on all funding sources at the two banks which revealed a ridiculously low yield of 0.34% paid by Wells Fargo and an also very low 0.92% for Bank of America.

Now, the spread here may not seem like a lot but we're talking about the rate paid on hundreds of billions of dollars. Every little bit counts and I now want to get into the other half of that number that can be found on the amount paid for the next largest contributor of lower costs, the bank's balance of long-term debt.

For reference, here is a look at the balance and average rate paid on this line item over the past three years (in millions):

2011 - $421,229 - 2.8%

2012 - $316,393 - 2.98%

2013 - $263,416 - 2.58%

As you can see, the balance is now 62% from where it was in 2011 and over the past year the average rate paid on that lower balance came down 13.4%. All told, Bank of America cut its long-term annual debt bill by $5 billion (42%) over the past two years.

The main contributor to this large cut was the off-loading of old Merrill's prior debts as the bank took advantage of deposit funding. Again, great for a $5 billion a year improvement but, can investors expect more?

Some of the other big banks have hinted at increasing long-term debt in 2014 but management at Bank of America expects theirs to stay steady with tier one currently ahead of peers. So, a big change may not be coming but a healing credit score means that the refinancing of maturing and higher-yielding debt could spell opportunity. To check this out I want to turn your attention to the bank's pipeline of maturing contractual obligations:

(click to enlarge)

As you can see, of the $249.6 billion balance of long-term debt, $46 billion or 18.5% is due in 2014. Compared to the average amount due over the other time frames, $46 billion looks to be slightly higher than 50% of the average yearly amount due. So, I'd say the odds are in favor of chipping away at the 0.92% cost of interest bearing liabilities. Especially considering that long-term debt costs the bank almost double the amount paid on the next most expensive liabilities (trading account liabilities), which is 82% more expensive than the one below it (Federal Funds and other short-term borrowings).

Now, without trying to be too confusing, investors should be aware that there is always another side of the coin when it comes to bank financials but a lot of that bad has already been paid. When a debtor's (the bank) credit rating improves the debt it owes can be reevaluated upward because repayment risk has declined. Last year for instance, this move set back pretax earnings by $0.6 billion. A little sketchy but this amount represents the opportunity cost of not buying back the debt when the market valued it at a lower price prior to the repayment risk's reevaluation.

This was an immediate one-time adjustment but one that I believe will fail to compare to the lower annual cost paid on the new debt along with the upside the bank could gain from devaluation of the debt when, and assuming that, interest rates continue to move higher.

Bottom Line

Investors may not see a big move in some of the large numbers that have contributed to major improvements in the past year's liability costs but that doesn't mean all improvements are lost. There are a lot more savings to come and this one should be added to everyone's investment checklist. I hope this article helps but keep in mind, interest rates are very dangerous for the bank's assets regardless of credit quality. I for one see a very challenging year ahead but am long and will stay long as my net thesis is still positive.

I appreciate all comments and will start hunting for another piece to highlight in the upcoming weeks.

Source: Bank Of America: More Cost Cuts On The Way

Additional disclosure: I am long BAC and WFC through warrants.