Bank Of America Creates Value By Tight Expense Management

| About: Bank of (BAC)

Shares of Bank of America (BAC) are falling in Wednesday's trading session after the bank released a disappointing set of first quarter results before the market open. Halfway through the trading session shares are trading with losses of up to 7%

First Quarter Results

Bank of America generated first quarter revenues of $23.71 billion, up 5.5% on the year before. Disappointing is the 1.6% decline in net interest income, coming in at $10.9 billion. The shortfall was made up for by a 12.2% increase in non-interest income, coming in at $12.8 billion.

Excluding debt valuation adjustments (DVA), revenues fell by 8.4% to $23.85 billion as the company had a tough comparison and was hurt by tightening interest margins. Despite the drop, revenues came in ahead of consensus estimates of $23.4 billion.

As a result of strict cost control, the company was able to report some decent earnings. Non-interest expenses fell by 5.1% to $18.2 billion, shaving off roughly $1 billion in total expenses. Consequently, net income rose sharply to $2.62 billion, or $0.20 per diluted share. This compares to earnings of $0.03 in the first quarter and the fourth quarter of 2012. Despite the major improvement in earnings, they still fell short of consensus estimates of $0.22 per share.

CEO Brian Moynihan commented on the earnings, "Our strategy of connecting our customers to all we can do for them is working. Solid increases in loan growth to small businesses and middle-market companies, four straight quarters of steady growth in mortgage originations, record earnings in wealth management, and another quarter near the top in investment banking fees show we are balanced focused and moving forward."

Performance Across The Bank

Consumer Banking

Revenues and earnings in the consumer banking division were under pressure as interest rate spreads tightened even further. Revenues fell some 2.8% to $7.21 billion as the average loan balance outstanding fell almost 8% to $129.6 billion. Deleveraging among U.S. consumers continued as deposit balances increased by 8% to $502.5 billion.

Consumer Real Estate Services

Despite a 56% increase in residential home loans originations, coming in at $25 billion for the quarter, revenues fell compared to the year before. Total revenues fell little over 13% to $2.31 billion, while net losses widened to $1.31 billion. The bank is still struggling with the overhang of the Countrywide Financial acquisition, but has pushed to increase revenues in originations to benefit from the U.S. housing recovery.

Global Wealth And Investment Management

Bank of America's global wealth and asset management business saw a healthy quarter. Revenues rose by 6.6% to $4.42 billion on higher fees, driven by a 10% increase in assets under management. Results were driven by a solid performance of the acquired Merrill Lynch activities. Thanks to strict cost control the division was able to report a 31% increase in net income, coming in at $720 million.

Global Investment Banking

The investment banking division of the bank reported stagnant revenues of $4.22 billion. Net income fell some 15% to $1.34 billion as the company increased its provision for credit losses. Trading revenues in sales and trading and fixed income and currencies fell, but were partially offset by a strong debt markets performance. Again, the bank showed strict cost control in the division.


Just like many of its U.S. peers, Bank of America continues to fortify its balance sheet. Tier 1 common capital stood at $137.5 billion at the end of the quarter, for a Tier 1 common capital ratio of 10.58%. The banks total asset base rose by little over 1% on the year to $2.21 trillion. The tangible common equity ratio rose 36 basis points compared to last year, coming in at 6.94%.

For the full year of 2012, Bank of America generated total revenues of $91.8 billion, excluding debt valuation adjustments. Net income for the year came in at $4.2 billion, or $0.25 per diluted share.

Factoring in a 6% decline in Wednesday's trading session, the market values Bank of America at around $124 billion. This values the bank at roughly 1.35 times annual revenues and 29-30 times annual earnings.

Bank of America pays a symbolic quarterly dividend of $0.01 per share, for an annual dividend yield of merely 0.3%.

Some Historical Perspective

Like many other major U.S. banks which have seen their shareholder base being severely diluted during the 2009 recession, Bank of America's long term shareholders have seen terrible returns. Currently trading around $11.50, shares are still trading some 80% below highs set around $55 per share back in 2006.

Yet shares have recovered markedly from lows around $3 during the recession. In 2012 alone, shares nearly doubled from $6 towards $12 making the stock a top performer in last year's market.

Investment Thesis

As shares of Bank of America were among the best performers in the SP500 for 2012, expectations into the earnings report have been high.

Yet the latest earnings report indicates that past troubles are still hunting the bank's performance. Not only did the purchase of Countrywide Financial during the crisis make the bank hesitant to benefit from the recovery in the housing market, the bank yet announced another $500 million charge related to the settlement of three mortgage backed securities lawsuits.

The improved earnings and divestiture of non-core assets strengthened the balance sheet of the bank. As such, Bank of America received approval from the Federal Reserve to repurchase up to $5 billion in common stock, enough to retire 4% of total shares outstanding. The company is furthermore allowed to redeem $5.5 billion in preferred stock.

The expense management is impressive as the bank cut back on roughly $1 billion in costs over the past quarter, compared to a year earlier. The company has targeted some $8 billion in expense cuts by mid-2015 per annum, of which it hopes to achieve a run rate of $6 billion by the end of this year.

I guess investors are a little disappointed with a lack of a dividend hike, after the bank passed the stress test. Still, the $10.5 billion which will be spend on common and preferred share repurchases make perfect sense. The company redeems its expensive preferred stock and buys back its own stock at just 85% of its tangible book value of $13.46 per share.

These decisions make perfect sense, despite the fact that the bank could attract a wider shareholder base by paying out a higher dividend, in line with other banks.

To me the rationale capital allocation strategy and the strict expense control are strong signals that management takes its job to create shareholder value seriously. Wednesday's price action provides investors with an interesting entry point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.