The idea that bigger is better apparently only applies to a certain point in the banking industry. Bank of America (NYSE:BAC) in particular is trying to get better by getting smaller.
The simple math
Prior to the Great Recession, Bank of America's approach seemed simple. The company wanted to be as big as possible, and the more branches and employees, the better. In the last few years, however, the company began to realize that sometimes bigger is just wasteful.
Generally speaking, bigger banks are able to spread their costs across a larger income base. Banks that operate in multiple states also have the opportunity to grow loans and deposits in different geographic regions. In addition, bigger banks are able to handle the complexities of the current regulatory environment because of their size. At some point, though, size can become unwieldy, and Bank of America and its peers seem to think it's time to slim down.
Citigroup (NYSE:C), JPMorgan Chase (NYSE:JPM), and Bank of America, for example, have all been aggressive in cutting their workforces. B of A and Citi have also been closing branches. Wells Fargo (NYSE:WFC) may be the lone holdout among the four biggest banks. It actually increased its employee count by almost 4% in the last year.
If a bank can service the same number of accounts with less staff and fewer locations, it would seem that the result should be better profits. Financial institutions are leveraging software and internal data to aid in this process. By using software that projects the number of tellers needed during a business day based on historical data, a bank can potentially cut workers if the branch is overstaffed.
Better than before, but not the best
Cutting staff is one thing, but in terms of getting smaller, reducing problem loans can be a big boon. At the end of last quarter, B of A had a non-performing loan ratio of 2.3%. That's a solid improvement from 2.9% at the end of 2012 and 3.5% at year-end 2011.
Bank of America has seen overall loan growth even as its consumer-loan portfolio shrinks. Since the bank's biggest problems have been in the consumer loan portfolio, running off these balances while growing new loans should help lower the bank's overall non-performing percentage.
When we stack Bank of America against its big-bank peers, we can see that it's made some progress closing the gap, but it still has work to do. Wells Fargo finished the second quarter with nonperforming loans to assets of 2.2%, while JPMorgan was even lower at 1.3%. Citigroup is a bit of a special case because of its broken-out Citi Holdings division, but even when we look at the overall bank, the nonperforming loan ratio of 1.5% doesn't look too bad.
A measure that is not shrinking
In the last few years, Bank of America reported a decline in its net interest margin. With the rate it earns on its loans and securities portfolio dropping faster than the rate paid on its debt and deposits, the company was stuck with a shrinking margin. This issue is showing early signs of improvement, as the company's margin is now 2.4% compared to 2.2% last year. In addition, this marks the fourth straight quarter that Bank of America's net margin has improved.
However, Bank of America still has some work to do if it wants to be considered in the same league as its big bank peers when it comes to NIM. Wells Fargo leads the way with a net interest margin of 3.46%. Citigroup's margin sits at 2.85%, and JPMorgan Chase's margin is 2.6%. That being said, Bank of America appears to be on the right track, and if this improvement in net interest margin is sustainable, better earnings could be on the horizon.
Analysts expect big earnings growth from Bank of America over the next few years, so they may be believers in the "getting better by getting smaller" approach. With fewer branches and employees, along with improving credit quality and loan growth, a smaller Bank of America might mean bigger returns for investors.
Chad Henage has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, and JPMorgan Chase. 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.