Bank Of America Corp Earnings Preview: Profits To Jump In Q1 On Stronger Trading, Loan Loss Reserve Releases

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Bank of America
The company logo of the Bank of America and Merrill Lynch is displayed at its office in Hong Kong, March 8, 2013.

Bank of America Corp. (NYSE: BAC), the second-largest U.S. bank by assets, is expected to report a significant increase in first-quarter profit on Wednesday amid signs of relative strength in investment banking, brokerage commissions and mortgage banking. The lender also continued its cost-cutting initiatives and added to profit by tapping funds that had been designated to cover loan losses.

Bank of America is expected to report financial results on Wednesday at 7 a.m. EDT, followed by an earnings conference call at 8:30 a.m.

Analysts surveyed by Thomson Reuters predict the Charlotte, N.C.-based company will post earnings of 22 cents a share on revenue of $23.41 billion. The consensus estimate implies an increase of more than seven times from last year, when Bank of America earned three cents a share on $22.28 billion in revenue.

Over the past three months, the consensus estimate has moved up by one cent. During the past 30 days, six analysts have raised their earnings view on Bank of America, while four of them have cut their EPS outlook for the first quarter.

Operating profit will likely come in at $4.81 million, compared with $719 million a year earlier.

“We entered 2013 all about moving the ball forward and winning in the marketplace,” Bank of America Chief Financial Officer Bruce Thompson said during the company’s fourth-quarter earnings conference call in January.

The results include an annual retirement eligible stock compensation, which was $900 million in the first quarter of last year. Bank of America expects this year will be a similar amount.

In terms of provisions against bad loans, Thompson said: “We believe most portfolios are close to stabilization and overall reserve reductions are expected to continue but at reduced levels.

"Given our outlook for a slow growth but healthy economy, we believe provision expense in 2013 will range between $1.8 billion and $2.2 billion per quarter, the levels experienced between the second and fourth quarters of 2012."

Bank of America’s 2012 year-end nonperforming loans were 2.5 percent of total loans, down from 2.71 percent at year-end 2011. The lender’s net charge-off rate, or percentage of loans deemed uncollectible, fell to $3.1 billion in the fourth quarter, from $4.1 billion in the prior quarter. New nonperforming loans were $2.06 billion, down from a trailing average of $3.3 billion.

S&P Capital IQ's Erik Oja sees 2013 net charge-offs of $9.95 billion, down from last year's $14.9 billion, and loan loss provisions of $5.97 billion, or 60 percent of net charge-offs, down from 2012's provision of $8.17 billion, which was 55 percent of net charge-offs.

“This year, we see Bank of America’s revenues rising for the first time in three years, and we see earnings improving for the third year in a row,” Oja wrote in an April 6 note to clients.

Bank of America’s net revenue fell 10.8 percent in 2012, and 30 percent over the past three years, driven down mainly by lower trading account profits and lower equity investment income.

For 2013, Oja sees revenues rebounding to 4.8 percent growth, on 10 percent fee income growth, partly offset by flat net interest income. Fee income will probably benefit from lower legacy mortgage buybacks, while net interest income in 2013 should be helped by smaller declines in loan balances.

Bond Trading

The U.S. Federal Reserve’s quantitative easing program spurred a rebound in fixed-income trading. Investors’ hunger for yield helped drive gains in that business.

Fed Chairman Ben Bernanke has kept short-term borrowing rates close to zero, increasing demand for higher-yielding, riskier debt, or junk bonds, which Wall Street firms helped clients sell to investors.

Revenue from trading fixed-income securities jumped 21 percent, to $92 billion in 2012, from a year earlier, almost a return to levels in 2010, when sales from that business hit $98 billion, Bloomberg reports, citing industry analytics firm Coalition Ltd. Analysts expect this trend to continue.

CFO Thompson said the bank's broad cost-cutting initiative is “on track.” Bank of America Chief Executive Brian Moynihan announced the cost-cutting plan in 2011, under which 30,000 jobs would be slashed, saving the bank $8 billion by 2015. As of the end of 2012, the company had 267,190 full-time employees, down 5,404 from the third quarter. It had 14,601 fewer employees than it had at the end of 2011.

Despite the progress made in slashing headcount, JPMorgan analyst Vivek Juneja notes that Bank of America needs to continue to manage costs carefully, given its 40 percent compensation ratio, which is higher than the peer average.

Bank of America is also shedding noncore assets to raise capital. As part of its global strategy to move away from its international wealth management business and focus resources on markets where it has more competitive strengths, Bank of America in December announced that it is disposing of its Japanese private banking joint venture with Mitsubishi UFJ Financial Group Inc. (TYO:8306) to the Japanese group for about 39 billion yen.

The joint venture -- Mitsubishi UFJ Merrill Lynch PB Securities Co. -- was formed in May 2006 by MUFJ and Merrill Lynch Co. The joint venture was integrated into Bank of American’s operations after it acquired Merrill Lynch during the height of the financial crisis in 2008.

The decision to sell the joint venture in Japan follows Bank of America’s sale of its loss-making, non-U.S. wealth management business to Swiss private bank Julius Baer Group Ltd. in August.

Litigation Risk

While the financial giant moved closer to ending its mortgage troubles, the legacy of the 2008 financial crisis still weighs on the bank’s performances.

In the fourth quarter, Bank of America’s revenue fell about 25 percent, to $18.7 billion, a drop that stems from the steep charges tied to mortgage settlements with the government. The figures underscored the extent of the bank’s mortgage woes, which it largely inherited from Countrywide Financial, the subprime lending giant it bought in 2008. Without the various charges, fourth-quarter revenue would have totaled $22.6 billion.

However, Bank of America also noted that the one-time legal charges, which skewed the bank’s performance, helped it to continue shedding the legacy of the crisis.

“We put a lot of risk behind us in 2012,” Thompson said in a conference call in January. “We just feel like we’re in a much better place going into 2013.”

Bank of America closed another dark chapter in its history in September, when it agreed to pay $2.43 billion to settle claims it misled investors about the acquisition of brokerage firm Merrill Lynch & Co. Merrill Lynch was initially valued at $50 billion in Bank of America stock in the midst of the 2008 Wall Street meltdown. Then-CEO Kenneth Lewis called it the "deal of a lifetime.”

The payment is the largest settlement of a shareholder claim by a financial-services firm since the upheaval of 2008 and 2009.

On April 5, a settlement was approved by U.S. District Judge Kevin Castel in Manhattan. Castel called the settlement "fair, reasonable and adequate," and said it culminated an "extraordinarily hard-fought litigation."

During that same week, Bank of America reached a $165 million agreement with a federal credit-union regulator, settling allegations that the bank played down the risks of poor-quality mortgages packaged into securities.

The company said in a February regulatory filing it had agreed to a preliminary settlement on Jan. 11 that will be covered by existing reserves.

The settlement adds to a growing list of mortgage-related legal troubles Bank of America has been able to put behind it, after sustaining more than $40 billion in losses from its home loan business since the financial crisis.

Bank of America announced more than $14 billion in settlements in January alone.

The financial giant still faces a variety of litigation over its mortgage operations. “Litigation appears to have only accelerated over the last 12 months as private investors, correspondents and various government agencies continue to pursue legal claims against the largest banks," wrote industry analysts at Sterne Agee & Leach.

"In particular, we remain concerned with Bank of America's potential litigation and outstanding mortgage repurchase risk," Todd L. Hagerman wrote.

Stock Performance

FactSet projects that in the first quarter, the Financials sector had the second-highest earnings growth rate of any sector at six percent. This still marks a drop in earnings growth for the sector from the 16. 6 percent growth reported in the fourth quarter of last year and the 11.7 percent growth reported in the third quarter of 2012.

“However, the first quarter is expected to be a trough in earnings growth for the Financials sector,” said John Butters, senior earnings analyst, at FactSet.

The 81-company Standard & Poor’s 500 Financials Index climbed 54 percent in the 18 months ended March 31, outpacing the 39 percent advance for the broader S&P 500 (INDEXSP: .INX). Of the six largest lenders, the top performer was Bank of America, which doubled.

That said, “the stocks are still cheap, fundamentals are improving and bank cycles generally are long,” Chris Kotowski, an Oppenheimer & Co. analyst, said in an April 4 note.

Of the 31 analysts covering Bank of America, just 3 are urging their clients to sell, according to data compiled by Thomson Reuters.

Currently, Bank of America is trading at 92 percent of the median target price ($13) set by analysts, according to data compiled by Thomson Reuters.

Last month, Bank of America authorized the repurchase of up to $5 billion of common stock and the redemption of about $5.5 billion in preferred stock. The move came after the Federal Reserve did not object to the company's capital plan. However, the 2013 capital plan didn't include a request to increase the quarterly common stock dividend rate of one cent a share.

Bank of America stayed above a minimum generally accepted regulatory capital standard based on initial Federal Reserve stress test results released in March seeking to find out if the big bank can withstand a deep recession.

The test showed that Bank of America had a minimum of 6.8 percent of capital set aside under a measure called Tier 1 common ratio, above the generally accepted standard of five percent. In that scenario, where the U.S. is experiencing 12 percent unemployment, Bank of America is projected to lose $52 billion with loan losses of $58 billion.

JPMorgan Chase & Co. (NYSE: JPM) reported last Friday its net income rose 33 percent, to $6.53 billion, or $1.59 a share, as a jump in investment-banking income and a cut in expenses helped cushion the mortgage pullback.

On the same day, Wells Fargo & Co (NYSE: WFC) said its profit increased 22 percent, to $5.1 billion, or 92 cents a share, as the San Francisco bank reported cost savings.

Citigroup Inc (NYSE: C), the third bank to report earnings, reported on Monday a 30 percent jump in first-quarter net income to $3.8 billion, or $1.23 a share, and a 6 percent increase in revenue, to $20.5 billion, helped by strength in investment banking.

Goldman Sachs Group Inc. (NYSE: GS) is scheduled to report on Tuesday morning, followed by Morgan Stanley (NYSE: MS) on Thursday.

Shares of Bank of America closed down 1.56 percent, or 19 cents, at $11.98 apiece in Monday’s trading.

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