Bank of America (NYSE:BAC) is scheduled to report second-quarter earnings before the market opens on July 15. Here are three things investors should watch for when it does so.
Since the onset of the financial crisis, Bank of America has struggled to earn a satisfactory return. Hobbled by a bloated expense base, heightened loan losses, and astronomical legal fees, the nation's second-biggest bank's return on equity has eclipsed 5% only once on an annual basis since 2008.
It's generally assumed, meanwhile, that a 10% return on equity is necessary to adequately compensate investors for the opportunity cost of investing in a bank.
With this in mind, the first number that investors will want to check when Bank of America reports earnings is its quarterly return on equity, calculated by dividing a bank's net income by its shareholders' equity.
While this number should exceed 10%, as it almost always does at Wells Fargo and JPMorgan Chase, the goal for Bank of America is more modest. It simply needs to see the figure head in the right direction. At a minimum, it needs to come in comfortably above the 3.68% return on average common shareholders' equity that it reported in the second quarter of last year.
Aside from the suffocating litany of legal fees and settlements that Bank of America has incurred every year since the crisis, its biggest problem is simply that its expenses are far too high.
Analysts and commentators use the efficiency ratio to assess this. The metric is computed by dividing a bank's noninterest expenses by its net revenue. The bigger the number, the less profitable the bank.
Ideally, you want to see a ratio in the 50% to 60% range, which is where well-run banks such as Wells Fargo and US Bancorp typically fall. In the first three months of the year, for example, Wells Fargo's efficiency ratio came in at 58.8%, while US Bancorp's was 54.3%.
By contrast, Bank of America's efficiency ratio in the first quarter was 84.4%. This means that only 15.6% of its net revenue was left over to pay taxes, cover loan losses, and return to shareholders by way of dividends and share buybacks. Suffice it to say that investors will want to see this figure come down.
3. Legacy assets
The third thing to watch when Bank of America reports earnings on July 15 are the figures surrounding its legacy assets and servicing division. This is the unit that houses the toxic and "non-core" assets that Bank of America is in the process of unwinding.
There are three numbers in particular that shed light on the progress in this area. The first is the dollar amount of mortgages serviced by Bank of America for third parties. Generally speaking, these are much more expensive for the bank to service than the loans that it both owns and services.
The second number is the number of people employed by the legacy assets and servicing division. More than perhaps any figure, this reflects the overall progress Bank of America has made at offloading unwanted assets and exiting peripheral business lines.
And for the same reasons just given, investors will want to see expenses from the legacy assets and servicing division also headed in the right direction -- that is, down. Taken together, in turn, these three metrics serve as a progress report on Bank of America's ability to distance itself from the financial crisis.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of 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.