By Robert Gordon
Under Title II of the Dodd - Frank Wall Street Reform and Consumer Protection Act, all banks with over $50 billion in assets over which the FDIC has jurisdiction is to eventually supply the agency with written summaries of their resolution plans in the event of the sort of economic meltdown that occurred late last decade. The idea of these plans is that they should allow for the orderly dissolution of the bank at issue without jeopardizing the banking system as a whole, and also without requiring taxpayer support such as the TARP program.
The first volley of these reports was for only those banks that included more than $250 billion in non-bank assets. As months go on, more and more subgroups of banks will be required to report, until all banks of over $50 billion have done so. The current batch of banks with over $250 billion of non-banking assets encompasses only major institutions, typically with an investment banking arm. The only domestically based banks fitting with the FDIC's first round criteria are JPMorgan Chase (JPM), Citigroup (C), Bank of America (BAC), Goldman Sachs (GS), and Morgan Stanley (MS). The latter two have little to no presence as commercial banks, and nearly all their assets are "non-banking" in nature. But today I am going to look at Bank of America.
One fascination I have had with Bank of America over the past 18 months is a sense of opaqueness in its financial reporting. Each and every quarterly report has been filled with onetime events, often in the billions of dollars. It has been one thing to have been exiting non-core businesses and selling those assets. But the string of multibillion dollar credit and debit adjustments has been maddening.
Bank of America's resolution report went so far as to itemize the individual non-core businesses and investments that have been liquidated, of which there were over 20 such transactions between January 1, 2010 and December 31, 2011. Of course, asset sales have continued into 2012, such as Merrill Lynch's international wealth management arm that Reuters reported as up for sale in the second quarter of this year, are continuing. Bank of America wants all operations to fit under one of the three core groups: individuals, corporate, and institutional investors. And it has offered six core operating principles. Sadly, "transparency" is not among those principles.
The upside of all those asset sales is that indeed, Bank of America has had a balance sheet transformation since 2009. The company's Tier One common ratio has more than doubled since the end of the first quarter of 2009's 4.49% to the March 31, 2012 level of 10.78%. Global excess liquidity has nearly doubled during the same three year period, from $219 billion to $406 billion. That is an important increase, as it will allow Bank of America to self-fund nearly all of its day to day operations without resorting to credit markets.
In recent years, Bank of America has had dreadful efficiency ratios. That is, the ratio of its non-interest expenses, to the sum of net interest income plus non-interest income has been too close to 1.0. A well run bank has such a ratio of under 0.60, and the very best, such as U.S. Bank (USB), run efficiency ratios of close to 0.50. In the first quarter of 2012, the ratio was 0.86, which is just a ridiculous number for an institution of Bank of America's size, and indicative of its problems. Its net interest income was too low, its non-interest income was too low, and its non-interest expenses were too high.
Many banks, such as Fifth Third (FITB) and PNC Financial (PNC), saw huge increases in mortgage fee income in the first quarter due to refinancings. But Bank of America no longer will buy any mortgage not generated by its own employees, and therefore, has deprived itself of a prime revenue generator. At least Bank of America has launched its "NEW BAC" program, the goal of which is to bring non-interest expenses down by $5 billion annually by the end of 2014, mainly by laying off 30,000 employees. That will not be good enough unless revenues also increase. In the first quarter of 2012, had expenses been $1.25 billion lower, Bank of America's efficiency ratio would have been 0.79, still a very poor number.
Bank of America was among the many large banks to have suffered downgrades of their credit worthiness by Moody's (MCO). As a result, Bank of America's debt rating is just two notches above junk status. It is getting to the point where many of the larger, institutional clients will want to do business with a more secure company. Given Bank of America's retreat from the mortgage market, and its abysmal record on small business lending, it is difficult for me to see where the company is going to get the kind of core revenue growth that will be needed to truly turn itself around.
Just for the sake of a contrast, U.S. Bank received a "C" grade from the Multifunding.com grading system on small business lending. It recorded a 6.4% increase in its loan portfolio from the first quarter of 2011 to the first quarter of 2012, leading to a 7.3% gain in first quarter net interest income. It also had an 11.5% increase in non-interest revenue, largely supplied by a 150% rise in mortgage fee income. Overall revenue in the first quarter increased by 9.1%, or over $400 million. The rise of non-interest expense was offset by a declining provision for loan losses, leading in turn to a 28% increase in income from the year earlier quarter. U.S. Bank's return on assets of 1.60% and efficiency ratio of 0.51 are without equal in the large banking world. The downside of its efficiency is that there is little more that can be squeezed out. U.S. Bank has shown a both a commitment and an ability to grow its loan portfolio, and that will lead to further income growth.