Bank of America Corp. (NYSE: BAC)-Improved Credit Props up Bank of America’s Q3 Profits

Valuation by Rajiv Singh

Bank of America Corp. (NYSE: BAC) beat analysts’ profit expectations for Q3 2013 by reporting a profit of $2.5 billion or 20 cents per share ($340 million in the year ago period) as a result of cost cutting measures and $800 million from the sale of its stake in China Construction Bank. Since last year, the bank has eliminated more than 24,600 jobs, or 9% of its employees.However, the bank failed to meet revenue forecasts owing to a slowdown in mortgage lending. Revenue rose 5.4 percent to $21.53 billion as compared to Thomson Reuters’forecasts of $22.03 billion. Bank of America’s stock is up 23% this year despite concerns about rising interest rates and the debt ceiling dilemma.

As shown below, during Q3, its consumer and business banking segment’s net income skyrocketed to the highest level as compared to Q3 2011.

BOA
Source Bank of America

As the bank continues to witness a more normalized level of earnings, it was hit by lower fixed income revenue and a decline in the market for home refinancing. Fixed income, currency and commodities trading revenue fell to $1.77 billion ($2 billion in the year ago period and $2.29 billion in Q2 2013). Further, its equities trading revenue increased to $945 million ($667 million in the year ago period and $1.2 billion in Q22013).

Its global markets arm, which includes fixed income, currency and commodities trading, reported a loss of $778 million (loss of $276 million in the year ago period and profit of $958 million in Q22013). Mortgage banking non-interest income plunged 71% to $585 million (compared to the year ago period and 50% from Q22013). Overall, the consumer real estate division reported losses of $1 billion ($857 millionin the year ago period and $937million in Q22013).

Bank of America’s results were largely driven by improving credit quality. Credit loss provisions fell to $296 million ($1.8 billionin the year ago period and $1.2 billion in Q22013) and non-interest expense dropped by6.6% to $16.4 billion from the year ago period but rose 2.3% from Q22013.

Source: Bank of America
Source: Bank of America
Source: Bank of America
Source: Bank of America

Meanwhile, the global banking arm’s profit amounted to $1.13 billion ($1.15 billion in the year ago period). Net income from its wealth and investment management division rose 26% to $719 million, while pre-tax margin rose to 25.5% from 22.2% in the year ago period. Net interest income rose to $10.27 billion ($9.94 billion in the year ago period and $10.55 billion in Q22013); as a result, net interest margin improved to 2.44% versus 2.32% in the year ago period. Furthermore, total loans and leases were up $934.39 billion ($893.04 billion in the year ago period and $921.57 billion in Q22013).

Source: Bank of America
Source: Bank of America

BAC has fully phased-in under Advanced Approach of Basel 3 subject to approval by banking regulators. The company disclosed Basel 3 Tier1 common ratio of 9.94% as of Q32103, up 34bps from 9.6% in 2Q2013. BAC also estimated its leverage ratio in excess of proposed minimum leverage ratio.

Source: Bank of America
Source: Bank of America

On a negative note, the aftermath of the mortgage meltdown continues to hurt the bank. Loan growth had been slower than during Q3, litigation expenses were at $1.1 billion ($471 million in Q22013 and $1.6 billion in the year ago period).

In a separate development, according to Financial Times,the Federal Housing Finance Agency is looking to fine Bank of America more than $6 billion for misleading mortgage agencies during the housing boom.

WSA on Bank of America Corp. (NYSE:BAC)

With better than expected revenue, WSA has revised its revenue target for BAC. Our expected EPS for Q4 2013 is $0.32, which makes the FY2013 total EPS of $0.94. We have also revised our 2014 and 2015 EPS targets to $1.12 and $1.25, respectively. We still maintain our SELL recommendation on the stock with a price target of $13.

Despite the improving asset quality, better operational efficiency and cost reduction, we do not see the stock moving above its current range as most of them have already been factored in the stock. Further, a slower than expected economic recovery in the US can exert a downward pressure on the stock.

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