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Slash and earn

15 July 2015 By Antony Currie

Bank of America’s best quarterly earnings in years highlight the tougher task ahead. The lender cranked out a profit available to shareholders of $5 billion in the three months to June as costs hit their lowest level since the end of 2008. Return on equity remains subpar, though. Core earnings would need to be almost 40 percent higher for the bank to beat its cost of capital.

BofA’s reported numbers don’t quite reveal the whole story. They include a roughly $900 million boost to the bottom line from three one-off extras: accounting changes on certain net interest income, proceeds from the sale of consumer loans and the release of reserves set aside for past mortgage issues. Without those, annualized return on common equity would fall from 8.75 percent, which doesn’t cover the cost of capital, to 7.2 percent.

That’s not to understate the progress boss Brian Moynihan and his team have made. Excluding litigation costs, they managed to reduce expenses 6 percent from last year’s second quarter, to $13.6 billion. That brought the expense ratio down to 65 percent, after stripping out one-off gains. It’s still way above the 58 percent or so that JPMorgan and Wells Fargo announced yesterday, but a marked improvement nonetheless.

Producing more sustainable returns will require cutting expenses as much as those two rivals have. It would add some $1 billion to core quarterly earnings. Even that wouldn’t be enough, though, to nudge net income above a 10 percent return on equity, generally considered an acceptable level for a big bank’s cost of capital. Getting there would require a net income increase of 39 percent – or $1.6 billion – based on adjusted profit to shareholders.

Closing the gap means finding new sources of revenue. That’s hard to do for all banks now. BofA shareholders will have to hope Moynihan can find more corporate fat to trim – and the Federal Reserve will hike rates sharpish. It’s looking like a long wait.

 

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