How Bank of America Reduced Expenses by $17 Billion a Year

9/25/15

By John Maxfield, MotleyFool

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The significance of efficiency cannot be emphasized enough when it comes to banking. Bank of America (NYSE:BAC) knows this well. Over the last four years, the nation's second-biggest bank by assets has reduced its annual operating expenses by $17 billion. If it continues on this trend, it will soon be able to compete effectively against highly efficient rivalssuch as Wells Fargo and U.S. Bancorp.

Given the size of Bank of America's cost savings, you'd be excused for wondering how it squeezed such an enormous amount of expenses out of its system. The answer to this is threefold, explained Chairman and CEO Brian Moynihan at last week's Barclays Global Financial Services Conference.

The single biggest contribution was Bank of America's Project New BAC, a cost-cutting initiative launched by the Charlotte, N.C.-based bank in 2011. Its purpose was to squeeze $8 billion a year out of core operating expenses, which it accomplished in 2014.

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The second-largest contribution came from the bank's legacy assets and servicing division, or LAS. Bank of America created this unit after the financial crisis to hold noncore and toxic assets, consisting primarily of subprime mortgages. At its peak, the LAS unit employed 41,800 employees, tasked with servicing delinquent loans. Excluding litigation expenses, a substantial share of which is typically allocated to LAS, the unit's quarterly operating expenses peaked at $3.1 billion.

It's here, in turn, where Bank of America has made probably its most obvious progress atoning for past mistakes -- principally its purchase of mortgage originator-cum-criminal enterprise, Countrywide Financial. It was able to cut LAS' head count by 70%, down to 12,600 at the end of the second quarter of this year. And the unit's expenses followed suit, falling from $2.7 billion in the second quarter of 2011 all the way down to $900 million in the second quarter of this year. This equates to an annualized cost savings of roughly $7 billion.

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Finally, outside of these two specific initiatives, Bank of America wrung out an additional $2 billion a year "from all other activities that weren't included in Project New BAC," said Moynihan.

Despite this progress, Bank of America continues to have work to do on the expense front. Its LAS unit is still servicing 132,000 loans that are delinquent by 60 days or more. These cost significantly more to service than loans that aren't in default. One of the bank's long-term focuses is therefore to close the "significant remaining gap to normalized servicing cost per delinquent loan."

Additionally, Bank of America launched a new expense initiative, known as Simplify and Improve, or SIM. The program's purpose is to build a "culture of expense discipline," presumably along the lines of Wells Fargo and U.S. Bancorp. Finally, the $2.2 trillion bank is still staring down the barrel of billions of dollars of potentially toxic home equity loans that don't start amortizing until 2016 and 2017, at which point Bank of America is likely to experience the final uptick in default-related costs, from charging off the loans to servicing them in an effort keep them current.

Lest there be any doubt, Bank of America's success on this front will set the tone for its success in the future, as highly efficient banks are able to compete much more rigorously against competitors' loan prices without sacrificing an undue amount of margin.

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