On January 15, Bank of America (NYSE:BAC) reported its earnings results for the fourth quarter of 2013. BAC reported revenues of $21.7 billion, beating street expectations of about $21.1 billion, and earnings per share of $0.29, beating expectations of $0.27. This substantial upside surprise was primarily due to financial engineering, or rather account and/or column shifting that is essentially transferring cash from some accounts and putting it into others. Investors should understand these maneuvers before presuming that current earnings results are solely related to ongoing and continuing banking business.
Beyond Bank of America's actual continuing business operations, a strong portion of its outperformance occurred through the withdrawal of $1.246 billion in loan-loss reserves. This essential shifting of already existing bank cash from one of its savings accounts into its checking was premised upon a reduced concern of future mortgage-related risk, founded upon the bank doing about half the mortgage origination business it did in the same quarter one year earlier. This transfer from reserves to available cash was roughly equal to one third of BAC's reported earnings, or a 50% increase from where they would have been without its addition.
Another benefit to earnings was that the bank only paid $406 million in reported taxes on its reported pretax income of $3.845 billion. This works out to a 10.6% tax rate, compared to BAC's historic average rate of about 25%. A key reason for this lesser than normal tax rate was because the bank added a one-time expense of $2.3 billion in the padding of its litigation reserves, despite the apparent ability to reduce its loan-loss reserves. This $2.3 billion expense was among BAC's largest in recent history.
Other than these balance transfers, the bank did do some traditional banking, but less than previously. To put the strength of these reserve changes into perspective, the bank's equities revenue was $191 million (compared to $1.246 billion in loan-loss reserves and $2.3 billion in litigation reserves), which itself was a 27% increase from the same quarter in 2012, or a 7% decrease from the previous quarter.
This Equities revenue strength was due to market share gains on the back of a strong U.S. equities market in the second half of 2013, as well as increased client use of margin and other related financing mechanisms. Alternatively, its mortgage business declined by about 49%, essentially halving on the back of higher interest rates and its probable effect upon both refinancing and closings.
Changing litigation and loan-loss reserves is essentially moving cash from one account to another. Further, if Bank of America had applied a 25% tax rate in Q4 of 2013, its EPS would have missed estimates. Similarly, if the loan-loss and litigation reserves were not altered during the quarter, BAC would have missed its estimates by at least as much as it reported a beat. As a result, investors should take this report with at least two grains of salt.
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