How Being Average Could Mean Billions for Bank of America

With the New Year upon us, there's one thing Bank of America (BAC 1.70%) should resolve to do which would lead to the delight of its shareholders.

In banking, a key number to focus on is the efficiency ratio, which measures how much each dollar of revenue cost the bank.

For example, if a bank had total revenues of $100 and expenses of $55, its expense ratio would be 55% (55/100). The efficiency ratio is a valuable number to keep an eye on because it measures how productive and effective the bank is at generating revenue and also how much of that revenue is available to shareholders.

In the case of Bank of America, it should resolve to do everything in its power to improve this key metric.

A review of 2013
For Bank of America, 2013 has been a year when its efficiency ratio improved significantly -- falling by 11 percentage points -- but it still trails its well-known group of peers:

*First nine months. Source: Company Earnings Releases.

As you can see, Bank of America is seemingly in line with its peers through the first nine months of 2013, however, JPMorgan's efficiency ratio is so high due in large part to the countless settlements it has had to resolve over the last year. To see a truly encompassing picture, consider how well Bank of America has performed relative to its peers since 2010:

Source: Company Earnings Reports. 

The reason for this stems largely from the immense litigation and settlement expenses that have plagued Bank of America since the beginning of 2010. Consider that Bank of America has paid out $43.9 billion in settlements since 2010, which is more than JPMorgan Chase ($26.4 billion), Wells Fargo ($9.5 billion), and Citigroup ($4.5 billion) combined. 

Yet to Bank of America's credit, it has long recognized that both its expenses from both litigation and general operating practices need to be reworked. While there are likely still further litigation expenses to come, they will presumably not be nearly as dramatic or substantial as the settlements that have already been resolved. In addition, it has embarked on a plan to further cut costs through its Project New BAC Initiative that it hopes will save significant amounts of money. So far, the plan has hit the goals it promised to investors.

Impact to shareholders
The noteworthy thing about an improved efficiency ratio is every cut in expenses directly translates to the bottom line of the company. In Bank of America's case, through the first nine months of the year, it has had $68.1 billion in revenue and $51.9 billion in expenses, which resulted in its 76.2% efficiency ratio.

By improving its efficiency ratio to 70%, it would mean its pre-tax net income would rise by $4.2 billion, or 32%, through the first nine months of the year. If it fell to 65% -- still well above its pre-crisis levels and its peers -- its pre-tax net income jumps by $7.6 billion, representing a nearly 60% improvement:

While it is somewhat naive to think all of this improvement could be had over just one year's time, it goes to show how much opportunity is still available to Bank of America if it simply improves some of the foundational principals of its business model.

There is no denying Bank of America has had a tumultuous last few years, but as the calendar turns to 2014, there is also no denying that opportunity still exists at the bank that has seen its stock price rise by nearly 35% over the last year.