Bank of America Corp. (NYSE: BAC), one of my least favorite banks mainly because of its leadership, turned in its best quarter in a long time.
The bank produced a return on shareholders’ equity of 10.8 percent in the first quarter of 2018.
This was the first time that the bank earned an ROE in excess of 10.0 percent since the third quarter of 2011 due to special factors. The last year that the ROE exceeded 10.0 percent was in 2007.
Over the past three years, Bank of America earned 6.2 percent, 6.7 percent, and 6.8 percent and the seven years before that, with one exception, the bank’s ROE was below 3.0 percent.
The 10.0 percent “marker” is relevant only as it is conceived as the “theoretical 10% cost of capital” for banks of the size of Bank of America.
With the exception of the third quarter of 2011, bank president and CEO Brian Moynihan, in eight years, had never produced a performance in excess of this “cost of capital” figure.
The question is, can Mr. Moynihan keep the performance of the bank at this level or above?
In recent years, the bank has been attempting to lift earnings by cutting expenses, concentrating on basic banking services that are of less risk, and by avoiding special charges that have resulted from past banking decisions and practices.
There were no special charges in the first quarter of 2018.
Bank expenses actually fell by one percent over the past year and the bank’s expense ratio dropped below 60.0 percent for the first time under Mr. Moynihan’s reign, down from 62.8 percent one year ago.
The other point emphasized in the earnings report was that the bank was beginning to benefit from rising interest rates. This is what management had hoped for, given the emphasis that had been put on getting back to “plain vanilla” banking.
Interest rates on lending have risen, but rates on loans have gained more than has the cost of deposits. For example, the interest the bank paid on interest-bearing deposits was only 3 basis points higher in the first quarter of 2018 than the 27 basis points total cost in the fourth quarter of 2017. Still, deposits were up 4 percent, year-over-year.
So, it appears as if some of the longer-term planning is paying off for Mr. Moynihan.
The interesting thing is that Bank of America made very little of the gains it made through trading in the more volatile equity markets. The other big banks put more emphasis on this result, primarily, I believe, because they don’t put as much emphasis on this activity as the others – and their revenues, consequently, are not as large. Still, the returns on equity trading in the first quarter were up by 38 percent, year-over-year.
Not so good was the fact that revenue from trading in fixed income, currencies, and commodities was down 13 percent, year-over-year.
One also must take into account the fact that, like other major banks, Bank of America also benefited from the Trump tax cuts.
Bank of America paid only $1.48 billion in taxes this year. This was down from $1.98 billion paid last year.
The tax rate of Bank of America fell by 6 percentage points from last year, from 23 percent to 17 percent. JPMorgan’s (NYSE:JPM) tax rate dropped by 5 percentage points from 23 percent to 18 percent; Citigroup’s (NYSE:C) fell 7 from 31 percent to 24 percent; Wells Fargo (NYSE:WFC) dropped by 8 percentage points from 27 percent to 19 percent; and PNC experienced a decline of 6 percent from 23 percent to 17 percent.
So Bank of America did pretty well.
However, as mentioned above, the real test begins right now. The bank’s return on shareholders’ equity came in over 10.0 percent in the first quarter of 2018. Can this performance be sustained or even increased?
Mr. Moynihan took eight years to achieve this level of performance. That is, most of the time that he has headed up this banking institution, the bank has not produced a steady return that exceeded its cost of capital. The shareholders have lost substantial amounts of return during this time.
I believe that he still has a ways to go to show that his business plan can produce the earnings needed to cover his cost of capital over an extended period of time.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.