IS THIS AS GOOD AS IT GETS FOR THE BIG BANKS? / THE WALL STREET JOURNAL

Is This as Good as it Gets for the Big Banks?

Huge lenders like Bank of America are turning in solid results, but their ability to do so in a less positive economic environment remains unproven

By Aaron Back



A Higher Bar
Price to book value over the last two years:

Source: FactSet



The laggards of American banking are at last producing unambiguously good results. The challenge for the banks now is to prove they can deliver healthy profits in less than ideal conditions.

Bank of America BAC -0.94%▲ said Monday its first quarter net income rose 30% from a year earlier to a record $6.9 billion. More importantly, its quarterly return on equity hit 10.8%, above the key psychological threshold of 10%. This comes on the heels of Citigroup reporting a decent 9.7% return on equity on Friday.

This was Bank of America’s best quarterly return since 2011, and Citigroup’s best since 2010, according to S&P Capital IQ. At Bank of America, pretax earnings were up 15% from a year earlier. 
The banks are benefiting from multiple tailwinds. Tax reform and years of economic expansion boosted growth, while higher interest rates, more active stock and bond trading and generally low loan defaults are all helping.
The banks deserve credit for steadily reducing expenses, winding down legacy portfolios leftover from the financial crisis and maintaining discipline on lending. At Bank of America the efficiency ratio, which measures operating expenses as a percentage of revenue, improved to 60% in the first quarter from 63% a year earlier. At Citigroup, it held steady from a year earlier at 58%.






The solid performance stands out compared with Wells Fargo , the industry’s new laggard, which has seen costs jump as it struggles to overcome a series of sales controversies. Investments in compliance are weighing on the bottom line, with the bank’s efficiency ratio rising to 65% in the first quarter from 62% a year earlier. The bank has little choice but to make these investments if it hopes to escape the Federal Reserve’s onerous limits on its asset growth.

Arguing that Bank of America can keep producing good results, Chief Financial Officer Paul Donofrio said the strong first quarter “is not an anomaly,” as it comes after several quarters of continuous improvement. The real question for investors is whether banks are at peak earnings and whether results will decline in a less perfect economic environment.

Bank of America’s shares now trade at 1.25 times book value, compared with just 0.6 times two years ago. That effectively prices in today’s higher returns. To keep rising from here, banks need to keep on improving.