Wells Fargo Is Still Light Years Ahead of Bank of America

Bank of America's disturbing trend of huge litigation charges against earnings poses a much greater risk than Wells Fargo.

Bob Ciura
Bob Ciura
Apr 28, 2014 at 9:30AM

Source: Flickr / Bryan Wright.

Generally speaking, the financial system in the United States is healing. More than five years removed from the worst financial crisis in decades, the nation's banks are suffering less from loan losses and are improving their capital ratios. Bank of America (NYSE:BAC) is a prime example of this, as it's strengthening its loan quality and capital position. However, Bank of America continues to be weighed down by a disturbing trend: taking huge charge-offs from litigation costs.

Other big banks simply don't have the litigation risk that Bank of America does, and are doing just as well to improve their balance sheets and grow their businesses. One such bank is Wells Fargo (NYSE:WFC), which looks like a superior alternative to Bank of America due to its much lower risk profile.

One-time or every time?
Companies frequently take one-time charges against their earnings if they incurred an unexpected expense during a given quarter. Usually, the market tends to overlook these charges, since they are not expected to continue in future quarters. And, because the market is a forward-looking mechanism, analysts and investors usually strip these charges and writedowns out to focus on adjusted earnings instead.

However, a problem presents itself when a company is taking one-time charges regularly. In Bank of America's case, these one-time write-offs appear to be occurring nearly every quarter. The reason is that Bank of America is struggling with litigation costs, which cause the company to set aside hundreds of millions of dollars every quarter.

The most recent quarter was particularly disturbing, because Bank of America set aside a shocking amount of money for legal expenses. The company took a $6 billion charge in the first quarter which caused it to incur a net loss for the period. That was much worse than analysts expected.

Is there really progress?
Separately, Bank of America actually showed improvement across several businesses in the quarter, with deposit balances increasing, net charge-offs decreasing, and the asset management division posting record fees.

Unfortunately, it's hard to see this progress in Bank of America's underlying business, because it's overshadowed by massive litigation expenses. That's why Wells Fargo looks like a better bank stock to buy right now. It's doing extremely well, and doesn't have the overhanging litigation risk to worry about. 

Moreover, Wells Fargo produced return on assets and equity of 1.57% and 14.35%, respectively. Bank of America couldn't generate returns on assets or equity because it posted a net loss, but even in the previous two profitable quarters, Bank of America's return on assets and equity rations couldn't measure up to Wells Fargo's.

Wells Fargo has profits and the shareholder rewards to prove it
While Bank of America can't produce profits consistently due to its massive charge-offs, Wells Fargo earned nearly $6 billion in profit in the most recent quarter, which represented 14% growth year over year. In turn, it's planning to increase its dividend by 17%. That gives Wells Fargo a compelling 2.8% dividend yield. In short, growth and income investors alike are getting a lot from Wells Fargo.

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Bank of America, on the other hand, is still grappling with billions of dollars in write-offs. These are become a recurring trend, which is disturbing since it defies the entire notion of 'one-time' charges. In all, Bank of America has set aside more than $50 billion in litigation expenses since absorbing Countrywide Financial during the financial crisis. Continued settlements pertaining to its mortgage loans are impairing the company's ability to produce profits. That's why investors would be better served buying Wells Fargo.