Bank of America (NYSE:BAC) reported earnings this morning and the greeting from investors has been quite rude. Shares are trading down nearly three percent as of this writing and in this piece, I intend to explain why I think that reaction is overdone and why there is reason for optimism in BAC's results that is being missed by investors.
Bears are winning the battle right now with shares getting hammered but the reasons, I believe, are shortsighted. One analyst says the reason the stock is down is due to a lack of clarity for how the bank will reach its EPS estimates this year and next. However, if this analyst was paying attention, adjusted EPS of 35 cents blew past the estimates that were for only 27 cents. And I know what bears will say; "adjusted" EPS is not EPS and they're right, but litigation is a one-time expense and is not part of BAC's core business. If you strip out all the noise from the earnings report, BAC had a great quarter. A $6 billion charge is not a normal occurrence and to reduce BAC's outlook due to this is shortsighted and imprudent.
In addition, the same analyst says that BAC has outperformed the banking index this year by 5% and that is a reason to sell. Really? Outperformance is in itself a reason to sell? Seems to me you want to own stocks that outperform, not sell them. There is no logic whatsoever behind this and it should be dismissed.
While BAC missed on its headline EPS number, there was a lot to like in this report. Net interest margins were up, although only slightly, to 2.36%. I believe this number, as I've stated in previous articles, will continue to increase as interest rates reset higher. This will not only lead to higher revenue but higher profit margins as well and since we didn't see a dip in NIM, we can still be encouraged as any increase is good news.
Charge-offs were significantly reduced as well. Provisions for credit losses and net charge-offs were down 41% and 45%, respectively, while the reserves release was more than cut in half. These are all outstanding numbers that further solidify BAC's improving fundamental backdrop. In particular, these numbers prove BAC's credit extension is more and more prudent, meaning profitable longer term income growth rather than chasing a quarterly production number, as was common practice during the Lewis years.
Significant cuts in legacy asset servicing led to an ex-litigation cut in expenses of $1.2 billion from the year-ago quarter, something that BAC shareholders have been watching for years now. Project New BAC is in full swing and we have more proof from today's results. In fact, this drop in expenditures is even larger than I thought it would be so I'm quite enthusiastic about this line item. This is the biggest item that is still holding back profit growth on the income statement in my view so seeing huge progress here is terrific.
Finally, equity positions have improved yet again as common equity on a Basel III basis inched up to an impressive 11.8%. While a 10 basis point improvement is nothing to get excited about, when you're talking about a number that is this high to begin with, any improvement means management is executing extremely well. This capital position enables BAC more flexibility to grow its business and return capital to shareholders in the coming years.
I will admit to being disappointed by the growth in tangible book value per share. I was hoping we'd see $14 this quarter but we are well short at the reported value of $13.81. The headline EPS loss didn't help and the litigation charge weighed significantly.
In addition, the boost to litigation reserves by $2.4 billion is a bit unnerving considering the enormous amount of money that has already been liquidated from shareholder coffers by the more litigious citizens among us since the crisis. I'm a little concerned the litigation reserves number will snowball in the coming quarters but perhaps management went big this quarter in the hopes that another large addition to the reserve won't be necessary. We won't know for some time but this will be very interesting to watch.
Overall, BAC had a very nice quarter. The litigation expenses are a huge negative but they are no reason to sell today. We received further proof that BAC's business is firing on all cylinders in 2014 off of a very strong 2013 and today's selloff makes no sense. The positive news overwhelms the negative here and for those considering a position, today would be a very good day with shares below $16.
Disclosure: I am long BAC. 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.