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2 Main Reasons Bank of America’s Capital Cushion Exploded

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It was definitely a "hurrah" moment when Bank of America's (NYSE: BAC  ) third-quarter earnings report revealed a pumped-up Tier 1 capital ratio of 8.97%, trumping that of Wells Fargo (NYSE: WFC  ) and JPMorgan Chase (NYSE: JPM  ) . Considering the bank's troubles since the advent of the financial crisis, this achievement is certainly a feather in the cap of CEO Brian Moynihan, who has made much headway with his Project New BAC in just a couple of years' time.

As I mulled over the reasons for this success, it occurred to me that the gains that B of A has made may not be based on a sustainable, long term business plan. As far as I can tell, Project New BAC is mostly about subtracting unneeded assets to bring in cash -- which makes me wonder: Once the balance sheet is all shored up, what's the plan to bring in new business?

Nipping and tucking only goes so far
In order to reach that illustrious capital ratio, Bank of America has been doing a lot of trimming over the past year or so, in two major areas: real estate holdings and mortgage servicing rights.

The bank has been selling off much of its real estate assets, claiming that it is not part of its core business. A few weeks ago, B of A and Fortress Investment Group (NYSE: FIG  ) signed off on the sale of 12 office buildings in New Jersey for somewhere between $375 million and $400 million, according to Bloomberg. The bank had been trying to sell the lot since May, noting that it was an asset it obtained when it bought Merrill Lynch.

Other big property sales include the Hearst Tower this past May to Parkway Properties (NYSE: PKY  ) for $250 million, and a downtown Boston skyscraper sold to Boston Properties (NYSE: BXP  ) for a cool $615 million. In all three cases, the bank is planning to lease blocks of space back from the new owners.

While those numbers look rather robust, they're mad money compared to the chunks of mortgage servicing rights that B of A has been offloading over the past year or so. This past June, it sold more than $10 billion worth of mortgage servicing rights to Nationstar Mortgage (NYSE: NSM  ) , a young mortgage servicing company in which Fortress has an interest.

There's evidence that Bank of America plans to speed up the pace of these sales. Recently, a Sterne Agee analyst noted that the bank has been shedding large pools of these servicing rights, in the neighborhood of $10 billion to $20 billion each quarter. In Q3 alone, B of A sold $19 billion worth -- certainly not chump change.

One Fool's take
This is a great way to whip the balance sheet into shape, no doubt -- and with new capital rules making servicing rights less attractive than they once were, it's understandable that B of A is unloading them. Ditto for real estate inherited through the Merrill acquisition. The problem I see here is that eventually, the paring knife will hit bone, producing no new gains.

Unlike peers JPMorgan and Wells Fargo, both of whom reported sparkly income numbers from the mortgage origination and refinance business, B of A continues to lag in that respect, as Countrywide's legacy takes up much of the bank's resources. Until Bank of America finds a way to pump up earnings, I see its current healthier outlook deteriorating rather quickly.

Is Bank of America petering out, or simply bulking up to move on to bigger and better things? To find out more about the obstacles it must overcome -- as well as any tricks it may have up its sleeve -- check out our in-depth company report on Bank of America. The report details Bank of America's prospects, including three reasons to buy and three reasons to sell. Just click here to get access.

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10/24/2016 9:57 AM
BAC $16.74 Up +0.07 +0.45%
Bank of America CAPS Rating: ****
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Boston Properties CAPS Rating: **
FIG $5.22 Up +0.05 +0.97%
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NSM $15.00 Up +0.21 +1.42%
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PKY $18.26 Up +0.07 +0.38%
Parkway Properties CAPS Rating: No stars
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