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The Most Valuable Part of Bank of America Corp

This article is part of a series on the complete valuation analysis of Bank of America  (NYSE: BAC  ) . For Jordan's full analysis, click here.

You wouldn't know it from the headlines, but Bank of America's traditional retail bank is on fire.

Today, let's run through the good and the bad of B of A's Consumer & Business Banking unit, detailing the most important earnings drivers for what could soon be one of America's best banks.

The good: deposits and loan losses
The Consumer & Business Banking unit is a very traditional bank built on the back of low-cost deposits and interest-earning loans and investments. This isn't the ugly stuff that people tend to shy away from when they talk about financial stocks. It's not an investment bank. It's not stuffed full of derivatives or "alphabet soup" investments. Rather, it's one of the best deposit gatherers in the country.

In the first quarter of 2014, Bank of America reported an astonishing $518 billion in deposits in its traditional banking unit. These deposits cost the bank just 0.07% in the first quarter, putting it among the best banks in the country at sourcing low-cost deposits.

If it weren't enough that Bank of America pays peanuts for deposits, service charge revenue has been coming in to the tune of more than $4 billion per year. Service revenue has declined slightly, but a 2% decline in light of an improving economy is nothing to worry about. It turns out late fees and overdrafts tend to peak in recessions, not recoveries.

And its lending and investments are doing fine, too. Although its net interest yield has been in decline as higher-yielding assets roll of the balance sheet, declining spreads have been offset almost entirely by a growing pile of earning assets. Net interest income is virtually unchanged from 2012 to 2014.

The bad: costs
There are really two models in traditional banking. Either a bank will have very high cost deposits, and thus low operating costs, or it will have very inexpensive deposits, and higher operating costs. C&BB fits in the latter category. Its customers are largely willing to forgo higher interest rates on their deposits in exchange for a vast branch network, online banking tools, and more customer service.

These costs are dragging down the bottom line. And although Bank of America has been slashing its branch count to contain and reduce costs, the reality is that it still spends heavily maintaining its network of branches.

In 2012, the bank had 5,651 branches. As of the first quarter of 2014, branches have been slashed to 5,095. These branches have been shuttered, and, in some cases, sold to other banks. Reducing branches has been very favorable for shareholders, who have watched the company's non-interest expense decline year after year.

Looking ahead
You can model the future for Bank of America's C&BB banking unit however you'd like. But at the end of the day, the biggest earnings driver is undoubtedly the company's plan to cut its costs by eliminating branches, and adopting smaller branches with fewer employees and more automation.

From first quarter 2013 to first quarter 2014, the bank cut 294 branches. Noninterest expense fell by $180 million per quarter during that time.

This is significant; it's equal to roughly 7% of Bank of America's first-quarter pre-tax income. And I think it's only just the start of additional cost-cutting measures necessary to drive down the bank's on-going operating costs.

Cost cuts are the biggest reason why I believe Bank of America can continue to generate excellent returns on capital it allocates to its Consumer & Business Banking unit. In the last two years, and including the annualized performance in the first quarter, the segment has generated returns on average allocated capital of greater than 22% per year.

So what's it worth?
A multiple on allocated capital makes most sense to me. Few banks earn 22% returns on equity year after year, and thus, a multiple of 2.5 times allocated capital makes sense. That's roughly in line with price-to-book value multiples other banks are getting. At that valuation, C&BB would be worth roughly $74 billion.

Insane? Not really. That same multiple values it at less than 12 times annualized, first-quarter earnings.

It may be too conservative, in fact, given how leveraged it is to a steepening yield curve. A modest half-percentage point increase in spreads would add roughly 30% to the bank's bottom line.

But we'll stick with a valuation of roughly $74 billion, which, I believe, builds in a reasonable margin of safety while ignoring the potential of a steepening yield curve and reduced operating costs. 

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For Jordan's full Bank of America analysis and total valuation number, click here.

Read/Post Comments (4) | Recommend This Article (5)

Comments from our Foolish Readers

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  • Report this Comment On June 04, 2014, at 8:19 AM, DavidTheJust wrote:


    Historically banks have found it very hard to grow deposits without growing their branch networks. Because of the expenses involved in running branches - this is something banks have been trying (and failing) to do for at least three decades.

    As a BAC shareholder I do hope that "this time its different" but recent banking history makes me reluctant to think that BAC can simply cut its way to greatness.

    I am, however, more confident in the roll-out of smaller and more automated branches with fewer personnel. The combination of high tech ATMs and the fact that people are increasingly banking on their smart phones makes this possible.

    Paradoxically, the prospect of increased branchless banking is also a potential threat to BAC's business. One of the competitive advantages that BAC currently has is that pretty much anywhere you move there will be a branch near you. But if you no longer need a branch you no longer need a mega-bank with a universal footprint. This means that BAC will need to stay at the forefront of technology and will also have to work on holding down fees while providing excellent service over the phone or by e-mail when customers need it.

    On balance I think BAC will do quite well in the next 10 years. I also think that investors are undervaluing Merrill Lynch's likely contribution to future profitability.

    Best wishes,


    long BAC

  • Report this Comment On June 04, 2014, at 12:04 PM, TMFValueMagnet wrote:


    I understand entirely -- banking has been driven by the branch networks in the past.

    I'm not suggesting that Bank of America can simply cut out half of its branches. Rather, like you, I think the shift toward smaller branches with fewer workers and more automation will help the bank become much more profitable. With more than 5,000 branches, there's still plenty to cut before customers begin wondering why they're using BAC in the first place.

    On BAML, I completely agree. Asset management is huge, and will be huge for BAC going forward.

  • Report this Comment On June 04, 2014, at 12:22 PM, SkepikI wrote:

    David: As a FORMER ML customer and one who recently re-read "Crash of the Titans" which I recommend to you, I doubt that BAC is any more than a carrion stuffed con shop for the unwary.... and yes that is inflammatory rhetoric but I bet it got your attention.

    To be less inflammatory, and more measured, BAC services are ones I can find cheaper and with less danger elsewhere. BOTH ML and BAC came near to losing the company on many occasions and the CEO/Chair combination and board cronyism that allowed it to come to that still exist, now "wonderfully all in one"

    There have been multiple warnings for investors that nothing has changed at BAC, just the "top dogs" turned out to be replaced with others of the same philosophy. Unfair, maybe...traps for the unwary, very likely. Putting a long distance between yourselves and idiots or thieves is nearly always a good idea....

    You might want to read Alyce Lomax's latest article too...BAC and JPM are two of the worst offenders over time in my book...

  • Report this Comment On June 05, 2014, at 7:52 AM, andrewboon2739 wrote:

    Interesting article, Banks should maintain an adequate loan-loss reserve through a none-quarter horizon, consistent with accounting standards and internal practices. I work with McGladrey and there are results from survey we conducted on loan loss ratios at banks that will interest readers of this article. It offers insights on loan loss credit trends and what to expect from general reserve factors to change over the next year? @ “2013 Loan Loss Reserve

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Jordan Wathen

"The liabilities are always 100 percent good. It’s the assets you have to worry about." - Charlie Munger

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8/31/2015 4:00 PM
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Bank of America CAPS Rating: ****