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Why Bank of America’s 1Q Performance Was Even Better Than It Seemed

By John Maxfield – Apr 21, 2017 at 10:40AM

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The nation’s second biggest bank by assets is on track to meet its profitability targets by the end of this year.

Bank of America (BAC -0.42%) had a very good first quarter according to almost all of the metrics that matter most to bank investors. But despite growing its earnings by 44% compared to the year-ago period, its performance through the first three months of 2017 was even better than most investors probably realize.

You can see this in three numbers, the first being its efficiency ratio. This is calculated by dividing a bank's noninterest expenses by its net revenue. The quotient reflects the percent of revenue a bank spends to operate the business, with a lower ratio better than a higher ratio.

Efficiency ratio calculation.

Bank of America's efficiency ratio in the first quarter left a lot to be desired. At 67%, it's seven percentage points higher than Bank of America's target of 60%, which also happens to be a standard industry benchmark.

But here's the thing: First-quarter expenses at banks tend to be higher than in the other quarters because that's when incentive bonuses typically hit a bank's income statement. After adjusting for seasonality and projecting those expenses across four quarters, Bank of America's efficiency ratio comes in at a much more palatable 62%.

Bank of America's headquarters in Charlotte, North Carolina.

Bank of America's headquarters in Charlotte, North Carolina. Image source: Getty Images.

You can do the same thing with Bank of America's principal profitability metrics. Its return on assets was 0.88% last quarter. That's an improvement over last year, when it came in at 0.64%. It's also above the 0.80% threshold that's necessary to trigger performance-based compensation for its executives. Yet it's below the 1% standard industry threshold that also happens to reflect Bank of America's own stated target.

Return on assets calculation.

As was the case with the efficiency ratio, however, if you annualize Bank of America's first-quarter performance by spreading its elevated compensation expenses over four consecutive quarters, its return on assets is nearly there, said CEO Brian Moynihan on the bank's quarterly conference call. If things continue in this direction, Bank of America could very well meet this target this year.

This is also true with respect to the North Carolina-based bank's return on equity. Most banks strive for a 12% return on tangible common equity, though Bank of America has been content to crack 10% in three out of the last four quarters. By adjusting it in the same way as the return on assets, this too should be at or near Bank of America's target by the end of 2017.

Return on equity calculation.

In short, so long as things continue heading in the right direction for Bank of America, and I think there's every reason to believe they will, then the end of this year could mark yet another important inflection point in the $2.3 trillion bank's ongoing efforts to put distance between itself and the financial crisis.

John Maxfield owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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