Bank of America's (NYSE:BAC) customers aren't the only ones who need to be worried about their credit score. If the nation's second biggest bank by assets is able to increase the rating on its long-term debt, it could save upwards of $2 billion a year in interest expenses.
The evolution of Bank of America's debt rating
Bank of America once had one of the highest debt ratings in the financial industry. For a decade prior to the financial crisis, Moody's rated the bank's long-term debt "Aa2." This meant its outstanding debt securities (including loans) with an original maturity of one year or more were "judged to be of high quality and subject to very low credit risk."
In March of 2007, Moody's went so far as to upgrade all of Bank of America's ratings. It did so as a result of the bank's "powerful market franchise and substantial earnings power," as well as the "95%" likelihood of government support in the event Bank of America stumbled.
All of this changed with the onset of the crisis in 2008. By the end of the following year, Moody's had dropped Bank of America's long-term debt rating to "A2," meaning it was considered "upper-medium grade and subject to low credit risk." By 2013, the rating had dropped even further, finally settling at "Baa2," a mere two notches above "speculative-grade."
While Bank of America's long-term debt rating has since increased one level to "Baa1," the damage wrought by the multiple downgrades over the last few years is substantial.
You can see this by comparing the interest rate the North Carolina-based bank currently pays on its long-term debt relative to the rates paid by the nation's two other nationwide depository institutions, JPMorgan Chase and Wells Fargo -- both of which, it's important to note, have higher long-term debt ratings than Bank of America.
In the first three months of the year, Bank of America paid 2.2% interest on its $240 billion in long-term debt. JPMorgan Chase paid 1.6% on $279 billion in long-term debt. And Wells Fargo paid 1.32% on long-term debt of $184 billion.
These may not seem like significant differences at first blush, but they most certainly are. If Bank of America had the same rating as Wells Fargo, and was thus subject to the same interest rate, then somewhere along the lines of $2 billion in annual interest expense would be freed up to fall to the bottom line. Excluding the impact of taxes, that would have boosted Bank of America's quarterly earnings over the past 12 months by an average of 23.6%.
The point here is that Bank of America's credit rating matters. As a highly leveraged financial institution, it lives and dies according to its ability to access cheap funds. As a result, if current and/or prospective investors want to gauge Bank of America's turnaround progress, watching the evolution of its long-term debt rating is a good place to start.
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.