If you're an investor in Bank of America (BAC 2.06%), there's one thing you should watch when the bank reports earnings on Wednesday: its expenses.
Just to be clear, we already know that Bank of America's first-quarter earnings will be anemic compared to competitors like JPMorgan Chase and Wells Fargo. Since the beginning of the year, analysts have reduced their earnings-per-share estimates for the nation's second-largest bank by 83%, dropping them from $0.30 per share down to $0.05.
The main catalyst for the downgrade was Bank of America's $9.5 billion settlement with the Federal Housing Finance Agency, entered into at the end of March. Among other things, the deal calls for a $6.3 billion cash payment and is expected to reduce the bank's earnings by $0.21 per share in the most recent quarter.
But this is an isolated event. The more critical issue concerns Bank of America's overall expense base. As you can see in the chart below, operating expenses consume an industry-leading 77.8% of the bank's revenue, leaving behind little profit to distribute to shareholders and boost book value.
It's for this reason that investors would be wise to watch and listen for two things when Bank of America publishes its results on Wednesday. The first concerns the added expense of regulatory compliance. If there was one theme that coursed through the annual reports of the nation's biggest banks, this was it.
"Compliance has become a top priority for our industry," said US Bancorp CEO Richard Davis. "Never before have we focused so much time, technology, money and brainpower on such an enterprisewide undertaking," noted JPMorgan CEO Jamie Dimon. And M&T Bank CEO Robert Wilmers talked at length about the efforts his bank is taking to comply with the heightened regulatory regime.
The second thing to watch is Bank of America's "legacy assets and servicing" subdivision, or LAS, which houses the lion's share of its toxic assets dating back to the financial crisis. This is the epicenter of the bank's problems, akin to Citigroup's "bad bank" Citi Holdings, and it's the primary drag on Bank of America's expenses and therefore earnings.
More specifically, as I've discussed before, there are three particular metrics that investors should keep their eyes on in this regard: (1) the noninterest expense associated with its LAS unit, (2) the number of LAS employees on staff, and (3) the quantity of third-party mortgages that LAS services. All three have been, and should continue to be, on the decline and the faster the descent the better for shareholders.
Will Bank of America's first-quarter earnings pleasantly surprise analysts like Citigroup or disappoint investors like JPMorgan? That remains to be seen. But looking beyond a single quarter, there's simply no question that Bank of America's expenses are the primary albatross hanging around its neck.
