Bank of America (NYSE:BAC) was founded over a century ago to serve mom-and-pop consumers who had long been shunned by other banks. In the aftermath of the financial crisis of 2008-09, however, it appears to be shifting its focus to commercial customers.
Over the past five years, while the $2.2 trillion bank has increased its commercial loan portfolio by 32%, or $96 billion, it has simultaneously decreased its consumer loan portfolio by 24%, or $156 billion.
These changes have yielded a more evenly balanced bank with respect to consumer and commercial lending. In 2010, more than two-thirds of Bank of America's outstanding loans were made to consumers. But by the end of last year, this had fallen to a little over half.
Bank of America has retreated most rapidly from lending to homeowners. Since 2010, the value of residential mortgages on its balance sheet has fallen by $55 billion while home equity loans are down by $53 billion. Indeed, there isn't a single type of consumer loan that Bank of America hasn't reduced its exposure to.
Some of this, of course, is likely the result of the bank's attempt to eliminate toxic assets dating back to the crisis, many of which consisted of loans to overextended homeowners or credit card holders. Just as important, it also seems reasonable to conclude that the strategic shift has also been informed by a number of fundamental differences between consumer and commercial loans.
The first is that commercial loans generally have shorter maturity schedules. Whereas a typical residential mortgage lasts for 30 years, the usual commercial loan carries a five- to 10-year term, if not shorter. With interest rates expected to rise in the foreseeable future, this is preferable because a 30-year loan at a fixed rate exposes a bank to the risk that interest rates, and thus funding costs, will climb higher in the long interim.
The second and related difference is that consumer loans are generally underwritten at fixed rates while commercial loans are more typically indexed to a short-term interest rate benchmark, such as the London Interbank Offered Rate or the federal funds rate. Again, in a rising rate environment like we're in right now, the latter are clearly preferable to the former.
The third reason is that large commercial loans offer better scale and profit potential relative to consumer loans. Compared to the amount of time spent underwriting a loan, the former generate more revenue than the latter and can thus fuel a bank's bottom line much more efficiently.
Finally, Bank of America's history with commercial lending is better than its history of consumer lending. Over the past five years, the North Carolina-based bank has charged off an average of $2.5 billion worth of commercial loans compared to an average of $16.9 billion in consumer loans.
At the end of the day, none of these points should raise alarm among shareholders in the nation's second-biggest bank by assets. That being said, it's nevertheless important for Bank of America's current and prospective investors to stay abreast of its ongoing evolution, as it continues to distance itself from mistakes it made in the lead-up to the financial crisis.