3 Things Bank of America Corp Needs to Do to Make Investors Happy

The three most critical things Bank of America needs to do achieve outperformance over the next 5 to 10 years.

Jun 12, 2014 at 7:24AM

Bank Of America

Bank of America's (NYSE:BAC) stock has been one of the most hotly debated investing stories over the past several years. Recently, the bulls have been been winning. Shares of Bank of America are up nearly 170% since the beginning of 2012.

However, much of that increase has been driven by multiple (Price to Tangible Book Value) expansion rather than growth in tangible book value. Over that same time period, shares of B of A went from trading at a 65% discount to tangible book value to a 17% premium today -- a multiple expansion of 161%.

While the outlook for the bank has improved, greater expectations have crept into today's stock price and the bank will need to execute on a few key areas going forward to drive long-term shareholder value.

With that in mind, we asked three Fools who cover the bank extensively what they believe is the most critical thing Bank of America needs to do achieve outperformance over the next 5 to 10 years.

David Hanson, Financials Bureau Chief: Many investors believe putting its legal and mortgage issues in the past is the most important hurdle Bank of America needs to clear, but that's a short-term problem. More importantly, Bank of America needs to focus on underwriting profitable loans through the next credit cycle.

Before the last downturn, Bank of America's credit metrics looked strong, but when the tide turned, the bank's loan book was exposed and nonperforming loans spoiled the books:

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Source: Capital IQ

The bank's consumer loan book (credit cards, home equity loans, etc.) was its problem area in the past so investors will want to keep a close eye on management's strategy on growing this business and how the bank is reserving against future losses. Another credit downturn will happen and banks will suffer, but the banks that don't have to decimate their earnings and capital levels with huge provisions will be ones that emerge stronger.

Patrick Morris, Banking Contributor: If I can be honest, there's a lot I like about Bank of America. It still trades at a discount relative to many of its peers, it's executing on many of its initiatives to grow its businesses in a profitable way, and while he may not be inspiring of the big name bankers, CEO Brian Moynihan is doing a great job leading the bank.

But one thing that always is eye-opening and would really make investors -- like myself -- happy, is better expense management. One way this is measured is its efficiency ratio, simply a measure of total expenses divided by revenue. And a glance over the last 5 years shows you where it was, and, regrettably, where it is:

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Source: Company Investor Relations.

Thanks to the legal settlement in the first quarter of this year, its efficiency ratio stood at 97.7%, and with a rumored $12 billion (or more) in legal settlements coming, that number isn't poised to go down anytime soon.

But even just a glance from last year's core businesses, meaning the legal costs are excluded, you can see some are quite high:

Tabl

Source: Company Investor Relations

While 61% is exponentially better than 77%, it still leaves something to be desired.

The reason this is important is because those expenses translate straight to the bottom line. If Bank of America was able to improve to say 55% in its core businesses (where it stood in 2009), it would mean nearly $5 billion more added to its net income. And that is to say nothing of what could come when the legal expenses finally stop.

Bank of America has a lot which will make investors happy, but if it continues to executive on slashing expenses, their smiles will get even bigger.

Matthew Frankel, Banking Contributor: One of the best ways for a bank to lower costs and operate more efficiently is to effectively cross-sell its products. According to a recent report, it costs eight to ten times less for a bank to sell additional products to existing customers than it does to pursue new ones.

Moynihan has been pushing Bank of America's staff to cross-sell, and so far it looks like its working. Last year, B of A sold three times as many 401(k) products to existing business customers as it did in 2012.

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The company has also been highly effective in selling credit cards to its customers, issuing more than a million new cards in the first quarter alone, up by more than 10% from the same quarter last year. However, there is still room for growing the credit card business among the bank's existing customers. Bank of America has the number one retail deposit market share in the U.S., but is number three in credit cards.

Additionally, there is still room for growth to cross-sell in other areas, such by selling Merrill Lynch's "Merrill Edge" brokerage accounts to the bank's retail customers. Wells Fargo, which is generally recognized as the master of cross-selling, says the average brokerage customer has a total of 10 different banking products with the company, as opposed to an average of six products for non-brokerage customers.

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David Hanson owns shares of JPMorgan Chase. Matthew Frankel has no position in any stocks mentioned. Patrick Morris owns shares of Bank of America and US Bancorp. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Wells Fargo and has the following options: short June 2014 $48 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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