Update: Bank of America

January 23, 2023 | Premium Service | As we navigate through bank earnings, one trend clearly visible through the fog of QT is that bank funding costs are rising faster than asset returns, an arithmetic relationship that defies spin. In the case of Bank of America (BAC), for example, interest expense rose over 400% in 2022 vs the previous year. Interest income, on the other hand, rose just 52% vs 2021.

Overall, BAC saw net income fall 14% YOY vs 2021. Although net interest income rose, non-interest income fell almost $4 billion. Notice that credit loss provisions shown below swung from a $4.6 billion GAAP benefit in 2021 to a $2.5 billion expense in 2022, a stark illustration of the income statement volatility caused by the FOMC’s open market operations .

BAC’s results continue to trail the other members of the top-five money center banks. This tale of glorious mediocrity is illustrated by the rising headcount and related expenses, and an efficiency ratio that is six points above JPMorgan (JPM) and the average for the 132 banks in Peer Group 1. We are fortunate to have the standardized data from the Fed for making such comparisons, however, because BAC consistently uses non-standard terms and presentation for its financials. The table below is from the Q4 2022 BAC results.

For example, as of the end of Q3 2022, BAC reported accumulated other comprehensive income (AOCI) to the Fed and other regulators on Form Y-9 of -$12.7 billion, but in the GAAP financials just released the Q3 2023 AOCI number is shown as -$4.3 billion. For year end 2022, BAC shows AOCI of -$16.1 billion. Does this mean that the number reported to the Fed for Q4 will be 3x higher than the GAAP number? We’re not sure.

BAC reported lower asset returns in 2022 than in 2021, a remarkable statistic that again separates the Bank of Brian from its peers. The chart below from the FFIEC shows the results for the top banks through Q3 2022. Note that all of the large banks are trailing the average of Peer Group 1, which includes all banks above $10 billion in assets. BAC is somewhere between Wells Fargo (WFC) and Citigroup (C) in terms of asset returns, even based upon the Q4 2022 results! Note too that U.S. Bancorp (USB) is just below Peer Group 1.

Source: FFIEC

BAC’s asset returns were down in Q4 2022, this as the rest of the industry saw earnings and asset returns expanding. Long-time readers of The Institutional Risk Analyst will not be surprised by these poor results, yet members of the financial press and the analyst community refuse to criticize BAC’s consistently mediocre performance.

When Gerard Cassidy asked Brian Moynihan about BAC’s future loan loss reserve build, the BAC CEO danced beautifully:

Gerard Cassidy: Alastair, on the loan loss reserving, and Brian just talked about the adverse case being about 40%. Can you guys share with us how much of the reserve building is what might be referred to as management overlay relative to what the models are specifically dictating on reserve building?

Brian Moynihan: We don't disclose that. But you might assume that there's a fair amount -- 3 components to this: one is what the models say; two is basically uncertainty, imprecision and other things we overlay and then a judgmental, and you might think that there's a fair amount of that right now with the uncertainty. But -- so the model piece of that would be a portion of it.

Both Moynihan and JPM CEO Jamie Dimon spent a lot of time talking about uncertainty during the earnings calls, especially when it comes to future capital requirements. We see less uncertainty in the numbers and more evidence that mean reversion is occurring with full force and more quickly than the operators or analyst community want to admit. All of the top four banks need to downsize 25-35% of assets in order to get back into line in terms of performance.

One key area of “uncertainty” is future provisions for loss, but we hear in the channel that regulators are making their views of future loss probabilities very clear in guidance to the top banks. This is significant to investors and risk managers because future reserve build reduces earnings 1:1. Add on top of this the “overlay” from regulators for a significant blood letting during 2023 due to mark-to-market losses.

The chart below shows net losses through Q3 2022. The results for Q4 for these banks are all up significantly, even if the absolute numbers are still low by historical standards.

Source: FFIEC

Total net charge-offs for BAC in Q4 2022 were $689 million or 26bp vs total loans and leases, double the previous year. Notice that three quarters of BAC’s losses come from the consumer book. The steep rate of change is where regulators are focused, one reason why Dimon has been so cautious in comments about future capital requirements. BAC added 75bp to capital in 2022 and is arguably above the new requirements. Regulators, however, expect credit losses to rise back to 2020 levels or higher during 2023.

BAC CFO Alastair Borthwick framed the issue between the regulators and potential dividend and/or share repurchase increases:

“I think the difficult part with Basel III endgame right now is we don't have the rules. So we got to wait, I think, until we see those. They'll go through a comment period. At that point, we'll offer much more perspective. But I'll say the obvious, banks have got plenty of capital. We were asked to take 90 basis points more in June. There's a lot of procyclicality already in things like the stress test and stress capital buffer and in CECL. And I think, look, we've shown our ability to perform and build capital, in this case, 75 basis points in 2 quarters. So we'll deal with whatever the ultimate rules come out with.”

While it is great to see BAC building capital for a potential storm, we’d like the team to focus a bit more on improving earning asset returns (2.2% in Q4 2022) and lowering the bank’s efficiency ratio. Until that key operating metric efficiency starts with a “5” handle, Brian Moynihan is not in the game in terms of boosting the share price.

If you want to be measured against JPM and USB, not underperformers like WFC and Citi, then BAC needs to boost asset returns and loan yields, and start cutting expenses aggressively. BAC reported an efficiency ratio of almost 65 in Q4, but JPM and USB are in the low 60s or high 50s.

Source: FFIEC

Disclosures: L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI

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