# BAC: Closing the Margin Gap with WFC

**SEE LAST**** PAGE OF THIS REPORT** Howard Mason

**FOR IMPORTANT DISCLOSURES** 203.901.1635

hmason@ssrllc.com

December 16, 2013

**BAC****: ****Closing the Margin Gap with WFC**

- Over the last three years, the net interest margin at BAC has risen from 64% to 72% of that reported by WFC (with the corresponding figures being 80% and 90% if we adjust for the adverse impact of BAC’s trading activities). To some degree, this is because WFC has been more effective at gathering deposits leading to an adverse asset mix-shift from loans to securities.
- Specifically, loans are 62% of interest-earnings (“IE”) assets at WFC down from 71% three years ago while the equivalent ratio at BAC has increased to 54% from 50%; BAC maintains a less favorable asset-mix in part because one-quarter of IE assets are associated with its trading book.
**However, the margin gap has also closed because****of relative improvements at****BAC****in key margin****drivers**including the yield on securities and, on the liability side, the tilt to low-cost savings account balances and non-interest bearing (“NIB”) deposits versus higher-cost, non-deposit debt:- The securities yield is 80% of that at WFC versus below 60% in 2010Q3
- Savings account balances are 46% of IB liabilities versus 33% in 2010Q3; at WFC, the increase is less to 62% of IB liabilities from 56%.
- BAC is now at near-parity with WFC around NIB deposits which represent 21-22% of IE assets at both banks; three years ago, the ratio was 14% BAC versus 17% at WFC.
- Non-deposit debt is 46% of IB liabilities versus 58% in 2010Q3; at WFC, the ratio has also fallen but by less to 21% from 27%.
- A key metric where BAC has lost comparative ground is the loan yield which is now 87% of WFC’s versus parity in 2010Q3. However, this is because BAC has de-risked its loan portfolio so that the risk-adjusted yield (i.e. loan yield less net loss ratio) improved to 80% from 50% of that of WFC.
- We expect BAC to continue relative improvements in its balance sheet and the margin to continue to improve in absolute terms (even if rates remain unchanged) and relative to WFC (notwithstanding its proportionately higher savings account balances which tend to contribute more to margin expansion as rates rise). We note that BAC’s net interest margin troughed at 2.2% in 2012Q2 and increased to 2.4% in 2013Q3 despite an adverse rate environment; over the same period, the net interest margin at WFC declined from 3.9% to 3.4%.

Investment Conclusion

The improvements in BAC’s balance sheet go beyond de-levering and have contributed to margin expansion since 2012Q2 in absolute terms (despite a less favorable rate environment) and relative to WFC. In part, this is because WFC’s margins have fallen because of its effectiveness in gathering deposits (with the excess invested in lower-yielding securities) but BAC is closing the gap with WFC in terms of key margin drivers other than the asset mix. These include the yield on it securities portfolio and, within liabilities, the tilt towards savings account balances (now one-half of interest-bearing liabilities versus one-third three years ago and versus WFC where the ratio is approximately flat at 60%) and non-interest bearing deposits.

We expect BAC to continue relative improvements in its balance sheet, and the margin to continue to improve in absolute terms (even if rates remain unchanged) and relative to WFC (notwithstanding the likely margin-lift as rates rise from its proportionately higher savings account balances). We note that BAC’s net interest margin troughed at 2.2% in 2012Q2 and increased to 2.4% in 2013Q3 despite an adverse rate environment; over the same period, the net interest margin at WFC declined from 3.9% to 3.4%

**Comparing the Net Interest Margin ****at BAC and WFC**

WFC generates a net interest margin (on a fully taxable equivalent or “FTE” basis) that is nearly 100 basis points higher than that of BAC: the specific results for 2013Q3 are 3.40% and 2.44% respectively. The difference is split roughly equally between the asset and liability sides; in other words, WFC has a yield at 3.72% that is just over 50 basis points higher than that of BAC and a cost of funds at 0.32% that is just under 50 basis points lower than that at BAC.

In part, the margin differential arises because of the impact of BAC’s trading activities. The trading book at BAC represents approximately one-quarter of interest-earning (“IE”) assets and generates a net interest margin of only 80 basis points. If we adjust for the impact of the trading book, we find a “core” net interest margin for BAC of just over 3% (see Exhibit 1).

*Exhibit 1: Adjusting the Net Interest Margin at BAC for Trading Activities*

**Key Margin Drivers**

Beyond the asset-mix, however, WFC has a higher net interest margin it generates better yields on its loan and securities portfolios (see Exhibit 2A where we refer to interest-earning or “IE” assets) and because, on the liability side, WFC pays less for non-deposit debt and has a more favorable mix: over one-third of interest bearing liabilities at BAC are non-deposit debt versus 15% at WFC, and WFC’s deposit mix is tilted more towards lower-cost savings accounts than CD’s (see Exhibit 2B where we refer to interest-bearing or “IB” liabilities).

*Exhibit 2: Comparing the Margin Drivers for Assets and Liabilities at BAC and WFC*

In practice, the reported net interest margin is not the simple difference between the yield on IE assets and the rate paid on IB liabilities because some portion of IE assets is funded by non-interest bearing (NIB) liabilities including NIB deposits and equity. At BAC, this proportion is 21% versus 27% at WFC (see Exhibit 3); the margin benefit to BAC of these NIB liabilities is greater than that to WFC, notwithstanding the proportionately smaller balance, because of the higher rate at BAC on IB liabilities. We note that BAC has higher proportionate balances of NIB liabilities than WFC but this does not translate to a commensurate margin benefit because the bank also has higher proportionate balances of NIE assets.

*Exhibit **3**: Margin Impact of Non-Interest Bearing Liabilities*

**Relative Improvements at BAC**

Over the last 3 years, BAC has meaningfully narrowed the gap with WFC on key drivers of the net interest margin (see Exhibit 4A for BAC and Exhibit 4B for WFC). Specifically:

- The securities yield at BAC is 80% of that at WFC versus below 60% in 2010Q3
- Non-deposit debt is 46% of IB liabilities versus 58% in 2010Q3; at WFC, the ratio has also fallen but by less to 21% from 27%.
- Savings account balances are 46% of IB liabilities versus 33% in 2010Q3; at WFC, the increase is less to 62% of IB liabilities from 56%.
- Net NIB Liabilities (i.e. the net of NIB liabilities and NIE assets) account for fund 21% of IE assets versus 10% in 2010Q3; the ratio has risen for WFC as well but not by as much – to 27% from 20%. The key driver is that NIB deposits at BAC are now in line with WFC at 21% of IE assets versus three years ago when the ratio at BAC was 14% versus 17% at WFC.

*Exhibit 4**A**: Margin Dynamics at BAC*

*Exhibit 4**B: Margin Dynamics at WFC*

A key metric where BAC has lost comparative ground is the loan yield which is now 87% of that of WFC versus parity in 2010Q3. However, this is because BAC has de-risked its loan portfolio so that the risk-adjusted yield (i.e. loan yield less net loss ratio) has improved to 80% of that of WFC versus 50% in the first half of 2010 (see Exhibit 4).

*Exhibit **4**: Risk-Adjusting the Loan Yields at BAC and WFC*