BofA Beats Earnings on Huge Adjustment, $650M AIG Settlement - Analyst Blog

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The trend of industry frontrunners beating or meeting earnings estimates has been maintained by Bank of America Corporation ( BAC ) which delivered a positive earnings surprise of 41.4% for the second quarter. Also, the company reached a $650 million settlement with AIG to resolve its residential mortgage-backed securities (RMBS) litigation. The company came out with adjusted earnings per share of 41 cents, beating the Zacks Consensus Estimate 29 cents. The number is also significantly higher than 32 cents earned in the prior-year quarter.

Results exclude 22 cents a share (after tax) in litigation expenses. Considering this one-time item, the company has earned 19 cents per share.

Lower provision for credit losses and higher-than-expected top line were the primary drivers of this impressive performance, before considering litigation expenses. Controlled expense line also supported the results. However, both top and bottom lines showed a year-over-year decline.

Shares of BofA were down over 2% in the morning trade, indicating that investors are disappointed with such huge litigation costs. The price reaction during the full trading session will give a better idea about whether investors consider the underlying strength in the company.

The quarter witnessed improved credit quality and higher brokerage assets. However, lower mortgage banking income and equity investment income were the downsides.

Investment banking performance remained decent. BofA Merrill Lynch was ranked #2 in global net investment banking with fees of $1.6 billion. While Consumer and Business Banking showed solid income growth over the year-ago quarter, losses in Consumer Real Estate Services increased significantly. Global Banking and Global Markets showed year-over-year improvement in net income during the quarter.

The company's balance sheet position remained stable and showed improvement in capital ratios. Reduced long-term debt due to maturities and efficient liability management were also among the positives.

Quarter in Detail

Fully taxable-equivalent revenues (net of interest expense) were $22.0 billion, down 4% from $22.9 billion in the prior-year quarter. However, this was above the Zacks Consensus Estimate of $21.6 billion.

Net interest income on a fully taxable-equivalent basis was $10.2 billion, down 5% from $10.8 billion in the year-ago quarter. Reduced yields on debt securities were primarily responsible for this decline. Net interest yield deteriorated 13 basis points (bps) year over year to 2.22%.

Noninterest income declined 4% year over year to $11.7 billion. Lower mortgage banking and equity investment income were primarily responsible for the downfall.

Noninterest expense was $18.5 billion, 16% higher year over year. Higher mortgage-related litigation expense was partially offset by lesser personnel expense. However, the company's aggressive cost containment measures were evident in the expense line as noninterest expense, excluding litigation expense, declined 6% year over year to $14.6 billion.

Book value per share as of Jun 30, 2014 was $20.16 compared with $20.75 as of Mar 31, 2014 and $20.18 as of Jun 30, 2013. Tangible book value per share as of Jun 30, 2014 was $14.24 compared with $13.81 at the end of the prior quarter and $13.32 at the end of the year-ago quarter.

Credit Quality

Credit quality continued to improve during the quarter with net charge-offs declining across all major portfolios. Provision for credit losses decreased 66% year over year to $411 million.

As of Jun 30, 2014, nonperforming loans, leases and foreclosed properties ratio was 1.70%, down 63 bps year over year. Quarter-end net charge-off ratio decreased 14 bps sequentially and 46 bps year over year to 0.48%.

Capital Ratios

At the end of the reported quarter, the company's common equity tier 1 capital ratio (Basel 3 Transition) was 12.0% compared with 11.8% at the end of the prior quarter. Tangible common equity ratio was 7.14% compared with 7.00% at the end of the prior quarter and 6.98% at the end of the prior-year quarter.

Our Viewpoint

The company's loss in the first quarter put a pause to its recovery story. Further, the detection of an accounting error earlier this quarter led it to revise capital ratios downward that added to the worries. However, the latest results and the settlement with AIG indicate its return to the right track based on underlying strength. In addition to realigning its balance sheet in accordance with regulatory changes, the company has been focusing on cost containment.

We expect litigation and various regulatory issues to stain its results in the upcoming quarters as well. But the measures taken by the company should help it to evade the challenges to a great extent.

Among other banking giants, Wells Fargo & Company ( WFC ), Citigroup Inc. ( C ) and JPMorgan Chase & Co. ( JPM ) have come out with second-quarter results so far. Though the industry backdrop was tough during the quarter and seasonal softness was blatant, all these big banks managed to report decent earnings.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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