Why Is This Intangible Asset Giving Bank of America Grief?

One of Bank of America's (BAC 3.35%) competitive disadvantages is the amount of goodwill the $2.15 trillion bank holds on its balance sheet. Classified as an asset, goodwill is little more than an accounting convention reflecting the premiums paid for past acquisitions.

You can't sit on it. It doesn't generate loans or deposits. You can't even look at it. It's intangible. Vacuous.

While goodwill isn't a problem for most companies, it is for banks. That's because banks make money by leveraging their shareholders' equity. The more a bank leverages, the more it can earn from its portfolio of interest-earning assets.

The catch is that regulators limit how much a bank is allowed to lever up. One metric regulators use to constrain leverage is the total risk-based capital ratio, which subtracts goodwill and other intangible assets from a bank's shareholders' equity and then compares the remaining amount to the bank's assets.

So long as a bank's tangible common shareholders' equity equates to 10% or more of its assets -- I'm talking specifically about the nation's biggest banks, including JPMorgan Chase (JPM 2.51%), Bank of America, Citigroup (C 1.41%), and Wells Fargo (WFC 2.74%) -- then everything's fine. But if a bank exceeds that, it's bound to face regulatory backlash.

This is a problem for Bank of America because it holds more goodwill than any other big bank in America, in both absolute and relative terms. As such, once goodwill and other intangible assets are excluded, its tangible common shareholders' equity declines by more than at any other major bank. This caps the size of Bank of America's balance sheet more stringently than it does JPMorgan Chase, Citigroup, and Wells Fargo's.

Data source: YCharts.com.

It shouldn't be a surprise, in turn, that JPMorgan Chase and Wells Fargo are able to lever up more than Bank of America -- Citigroup is an outlier in this regard, given its internationally focused business model and continued financial crisis-related challenges. At the end of the third quarter, Bank of America's shareholders' equity was leveraged by a factor of 8.4 to 1.0, compared with JPMorgan Chase's 9.8 to 1.0, and Wells Fargo's 9.1 to 1.0.

To put this in perspective, if Bank of America leveraged its capital to the same extent as JPMorgan Chase, its assets would increase by $364 billion. Given Bank of America's 2.1% net interest margin, which measures the yield on a bank's interest-earning assets, this translates into $7.6 billion in foregone annual revenue compared with JPMorgan Chase.

There are many other moving pieces here, of course, which allows for only the roughest of estimates in terms of forgone revenue, as Bank of America differs from JPMorgan Chase, Citigroup, and Wells Fargo, in a multitude of ways. But the fact remains that one of Bank of America's most tangible competitive disadvantages right now is the outsized amount of goodwill reflected on its balance sheet.