The Shocking Proof People Don't Trust Bank of America

Everybody knows Bank of America (BAC -0.21%) isn't the most popular bank among individual consumers like you and me. But what fewer people appreciate is how distrusted the Charlotte-based lender appears to be within its own peer group of sophisticated financial corporations.

Like people, corporations have credit scores -- or, more specifically, credit ratings. These are issued by a triumvirate of rating agencies: Standard & Poor's, Fitch, and Moody's. Take a look at the table below, which ranks the nation's four largest banks according to Fitch's assessment of their creditworthiness.

Source: Company filings.

As you can see, Bank of America is tied for last place, with a rating of "A" -- Fitch's ratings span from a highly coveted "AAA" down to "D," with intermediate scores, like a single "A," qualified with plus and minus signs as in grade school.

The significance of this is more than just reputational. Like individual consumers with lower credit scores, a bank with a lower rating must pay more to borrow money. I've depicted this in the following chart, which shows the interest rates these banks paid on long-term debt in 2013.

Make no mistake about it; elevated borrowing costs are a serious issue for a company like Bank of America. Fundamentally, banks are nothing more than leveraged funds that arbitrage interest rates. They borrow at low short-term rates (complementing these funds with a smaller portion of longer duration borrowings) and then lend the money back out at higher long-term rates, either via loans or various types of fixed-income securities.

It follows that higher borrowing costs necessarily weigh on a bank's profits. And, in fact, this is exactly what we see when we compare Bank of America to its most analogous competitor, Wells Fargo. The former has an interest rate spread of 2.27% whereas the latter's spread is a 3.27%.

On an income basis, this means Bank of America earns 20 basis points less on its interest-earning assets than Wells Fargo does -- this is calculated by taking the difference between the two banks' net interest margins. This seems minuscule until you consider that Bank of America held an average of $1.75 trillion in earning assets in 2013. Thus, multiply that by 0.2% and you get $3.5 billion in profit. This would have boosted the bank's net income to common shareholders by 35% last year.

The takeaway here is twofold. In the first case, this helps to explain why a bank like Wells Fargo is so much more profitable than Bank of America. Beyond this, however, it goes to show just how much more money the latter can earn once it finally gets its house in order.