Bank of America's Real Problem Isn't Costs or Legal Settlements... It's Revenue

This week, Bank of America reported a less-than-expected loss of $0.01 per share. That loss includes a $5.6 billion charge related to the bank's August settlement with the Justice Department that will largely put the banks regulatory and legal troubles behind it.

Today, thanks to CEO Brian Moynihan's Project New BAC strategic plan, Bank of America is on the verge of righting the ship. It's time for the company to celebrate! Right?

Kind of. Well... maybe. You see, there's this one problem that's keeping Bank of America from truly matching its high-performing rivals. And so far, it's unclear if Moynihan and company can actually solve this problem.

Project New BAC -- a success story without a satisfying conclusion

In his first initiative after becoming CEO in 2010, Moynihan's Project New BAC was a broad effort to streamline Bank of America's operations and businesses. It included shrinking the bank, selling off businesses, and reducing the bank's massive branch network. That also meant laying off workers -- 30,000 was the goal. All told, management sought to reduce expenses by $2 billion quarterly.

The plan officially rolled out in the third quarter of 2011; this was the game plan to make Bank of America an elite bank. But have you noticed anything missing from the equation so far? Keep reading... we'll uncover the missing component soon enough.

We'll use the bank's Sept. 30, 2011, results as a benchmark of progress made. At the time, Bank of America employed 290,000 full-time employees, operated 5,700 branches, had total assets of $2.2 trillion, and reported an efficiency ratio of 61.3% for the quarter. (The efficiency ratio is a measure of the bank's non-interest expenses relative to its total net revenue. The lower the ratio, the better.) Moynihan's target was to reduce the total headcount by 10%, give or take -- that's the 30,000 number mentioned earlier -- sell off non-core businesses to focus the operation, and achieve an efficiency ratio of 55%.

How has the bank done since?

For Moynihan and company, the earnings report this week marks the first time the company has achieved the $2 billion in savings originally targeted with Project New BAC. Mission accomplished, right?

The bank reported total assets of $2.1 trillion for the third quarter, a marginal decline from the Q3 2011 figure. Total banking centers are down to just under 5,000 across the franchise, a 12% decline.

The bank currently employs 229,500 full-time employees, more than double the decline targeted by Moynihan in 2011. The pace of those staff reductions seems to be increasing, as well, with a 7.4% reduction year over year, and a 2%-plus reduction from the second quarter.

The efficiency ratio reported this past quarter is a bit askew due to the bank's significant settlement charge mentioned above. The actual reported ratio was 91%, but that may be hiding significant progress.

Using some back-of-the-envelope math to add back that $5.6 billion charge, we can take a better look:

BAC Adjusted Efficiency Ratio Q3 '14
(Dollars in millions)
Non-Interest Expense 19,742
Less Settlement Charge 5,600
Adjusted Non-Interest Expense 14,142
Net Interet Income 10,219
Non-Interest Income 10,990
Net Revenue 21,209
Adjusted Efficiency Ratio 66.7%

The bank has not yet met that 55% goal and, in fact, has moved in the wrong direction by about 5%, even after adjusting out the full $5.6 billion settlement charge. And that's after eliminating more than 60,000 jobs, and closing 700+ locations!

What's the problem?

Digging into the bank's financials for both the 2014 and 2011 third quarters, one key change is Moynihan's struggle with the efficiency ratio. The efficiency ratio isn't just about cutting costs -- it's also about revenue, and revenue is down significantly.

Specifically, the bank's non-interest income is dramatically down during the three-year period since Project New BAC began. In Q3 of 2011, the bank generated more than $17 billion in non-interest income. In the 2014 third quarter, that number was just shy of $11 billion.

Income from lending is, for our purposes, basically equal from 2011 to today. The bank's expenses are higher by about $2 billion; but adjusting out the $5.6 billion settlement charge puts today's expenses right in line with Project New BAC's original goals.

The culprit, then, is that big, 63% decline in non-interest income. We can drill down one step further, and see exactly where that change is occurring.

BAC's Non Interest Income Q3 2011 vs 2014 Q3 '11 Q3 '14 Change
Card income $1,911 $1,500 $(411)
Service charges $2,068 $1,907 $(161)
Investment and brokerage services $3,022 $3,327 $305
Investment banking income $942 $1,351 $409
Equity investment income $1,446 $9 $(1,437)
Trading account profits $1,604 $1,899 $295
Mortgage banking income $1,617 $272 $(1,345)
Gains on sales of debt securities $737 $432 $(305)
Other income (loss) $4,616 $293 $(4,323)
Total Non-Interest Income $17,963 $10,990

Where is it occurring? Basically everywhere.

Some of this is a result of reductions in proprietary trading and investment banking businesses divested through the streamlining process of Project New BAC. Regulations have forced other non-interest businesses to scale back, as well.

The reality, though, is that you can't cut your costs forever. At some point, you have to find new revenue. It really is just that simple.

The very best CEOs manage costs AND grow revenue

Moynihan has proven masterful at cutting costs; but to truly turn the bank around, he must now prove himself equally adept at finding growth. Rising interest rates will certainly help, but that won't fully solve the problem. Some banks find this revenue in investment banking and advisory, others in mortgage fees and wealth management. It's unclear where Bank of America will turn.

Project New BAC was a terrific success. It focused the company on unifying a decade's worth of acquisitions into a cohesive and singular business. The challenge now is to transition this progress into a culture of efficiency, profitability, and growth. The latter is, unfortunately, much more difficult than the former.

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The article Bank of America's Real Problem Isn't Costs or Legal Settlements... It's Revenue originally appeared on

Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Bank of America. The Motley Fool owns shares of Bank of America. 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 .

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