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PNC Financial Services (PNC), JPMorgan Chase & Co. (JPM): One Place Where Bank of America Corp (BAC) Comes Up Woefully Short

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It’s no secret that the nation’s second largest bank by assets, Bank of America Corp (NYSE:BAC), has its fair share of problems.

Since the financial crisis, its earnings have been ravaged by the bank’s decision to double down on the subprime mortgage market on the eve of the financial crisis. Hardly a month goes by nowadays that it isn’t sued for some type of malfeasance.

But these problems are isolated. Have they been expensive to deal with? Sure. But there’s a light at the end of the tunnel, and that light is getting bigger and brighter with each passing day.

Bank of America Corp (NYSE:BAC)

The more concerning issue for prospective long-term investors is its net interest margin, as this is indicative of a systematic failure on the part of the management. Unlike the lawsuits and regulatory actions dating back to the financial crisis, there isn’t a natural ending point to this.

It’s important, here, to clearly understand what a bank does.

In short, a bank is not a bank — or, at least not in the traditional, conservative sense that most of us associate with one. It’s better to think of a bank as a hedge fund — albeit a heavily regulated one.

Banks make money by heaping copious amounts of debt onto a comparatively small kernel of capital — that is, leveraging — and then investing the borrowed funds into interest-earning assets — the most common and highest yielding of which are loans.

This is where the net interest margin comes in. Net interest margin is calculated by dividing the difference between investment returns and interest expenses by the quantity of earning assets.

Because the objective is to maximize the quotient, we can draw a number of general rules from its component pieces.

In the first case, banks want to maximize their investment return. This is accomplished by (1) maximizing the proportion of earning assets to total assets and (2) getting a higher yield on those assets.

To do the latter, moreover, it’s generally necessary to maximize the proportion of loans (that are higher yielding) to other types of assets like, say, high-grade investment securities.

And in the second case, banks want to minimize their interest expense. They typically do this by using deposits — and so-called “demand” deposits like checking accounts in particular — to finance their investments as opposed to credit lines from other financial institutions.

So, how does Bank of America Corp (NYSE:BAC) match up?

Let’s start with its net interest margin overall. In 2012, this came in at 2.34%. By comparison, the average of the nation’s 12 largest banks (excluding investment and custodial banks) was 3.33%, or nearly 100 basis points higher.

The best performer in this regard was Pittsburgh-based PNC Financial Services (NYSE:PNC), which recorded a net interest margin of 3.94%. And this is despite the fact that PNC Financial Services (NYSE:PNC) has more than doubled in size over the last five years thanks to its acquisition of National City Corp in 2008.

Taking a step down, Bank of America Corp (NYSE:BAC) performs almost as poorly when it comes to its ratio of earning assets to total assets. In 2012, its ratio was 80%, behind only JPMorgan Chase & Co. (NYSE:JPM)‘s 78%. The average among their peers was 85%. In other words, both of these institutions carried significantly more dead weight on their balance sheets (typically in the form of intangible assets) than their average competitor.

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