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Bank of America’s Capital Punishment

By Motley Fool Staff - May 16, 2016 at 4:42PM

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As a large universal bank, Bank of America must hold more capital than smaller, simpler peers.

This isn't how it was supposed to be. Bank of America (BAC 1.38%) once touted the synergies that would spring from its 2008 acquisition of Merrill Lynch. In reality, however, it seems like the combination is leading to more pain than profit at the nation's second biggest bank by assets.

In this segment of Industry Focus: FinancialsThe Motley Fool's Gaby Lapera and John Maxfield dig into the role that higher capital requirements for large universal banks play in Bank of America's subpar performance over the past eight years.

A transcript follows the video.

This podcast was recorded on May 9, 2016. 

Gaby Lapera: Now we run into our second hurdle, which is, again, a product of the new regulations that came with the financial crisis, which is capital requirements.

John Maxfield: Yeah. Let me give me some numbers to put this in perspective. Going into the financial crisis in 2007, Bank of America was leveraged $9.8 worth of assets for every $1 of equity. That's earning assets. After the financial crisis, that fell to $7.8 of earning assets for every $1 worth of equity. So, the question is, why did Bank of America's leverage fall by 20%? In trying to figure out the answer to this, one thing you can do is ask, did every bank's leverage fall this much? The answer to that is no.

You look at Wells Fargo (WFC 1.92%), it's basically operating with ... not exact same, but a very small reduction in leverage relative to where it was before the crisis. It went from $9.5 worth of earning assets for every $1 of equity down to only $9.2 worth of earning assets for every $1 of equity. So, the question is, why is Wells Fargo able to still operate with that much leverage, but Bank of America isn't?

The answer to that is the regulators came in and said, "Look, you large, global, systematically important banks like Bank of America, where you have both retail operations and investment banking operations, you have to hold a lot more capital than more traditional organizations." So, that's where that combination with Merrill Lynch and Bank of America is actually working against Bank of America, even though, when they got into the deal, there was a belief that there would be all these great synergies that would increase profitability.

Lapera: Right. And, again, before the financial crisis, there weren't these kind of stringent requirements on the systemically important financial institutions. I don't even know, did they have that designation before the financial crisis?

Maxfield: No, that's all a new thing as result of the Dodd-Frank Act.

Lapera: That's what I thought. I was also much younger when the financial crisis occurred, so I don't think I was following banks nearly as closely as I am now.

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Bank of America Corporation Stock Quote
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Wells Fargo & Company Stock Quote
Wells Fargo & Company
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