Bank Of America's Mortgage Problems Put Into Perspective

Apr.17.14 | About: Bank of (BAC)

Summary

Bank Of America is struggling with mortgage production revenue and has been for some time, as have all the big banks.

This revenue was a mere 1.2% of total revenue in the first quarter, making it immaterial in my view.

Investors should ignore this piece of the bear thesis and focus on what matters.

Bank of America's (NYSE:BAC) earnings yesterday caused quite the stir among investors and analysts with an eye on the details of the release. I detailed yesterday that I thought the report was actually quite good excluding litigation costs but investors disagreed, sending the stock down. One of the arguments I hear repeatedly from BAC bears is that the bank is having a rough time originating mortgages and as such, it cannot be a buy. This is an industry-wide issue that BAC has very little control over and in this article, I intend to explain why I think the mortgage piece of the bear argument is unfounded and misinformed.

It's actually quite simple really, as this quote from the press release shows:

"CRES first-mortgage originations declined 65 percent in the first quarter of 2014 compared to the same period in 2013, reflecting the decline in the overall market demand for refinance mortgages. Core production revenue decreased in the first quarter of 2014 to $273 million from $815 million in the year-ago quarter due to lower volume and a reduction in margins."

The thrust of the quote is that mortgage production revenue plummeted from $815 million in the year ago quarter to only $273 million in this year's first quarter. That is an awful, atrocious, brutal decline for any business and BAC is no doubt hard at work to remedy this situation as quickly as possible. However, I believe focusing on this piece of the release and the broader "mortgage" issues that banking in general have right now is missing the point.

The point is that this production revenue barely even qualifies as a fraction of BAC's total revenue. For the quarter, BAC produced $22.7 billion in total revenue net of interest expense, making production revenue 1.2% of total revenue for the quarter. Consider that for a minute before declaring that the sky is falling on BAC and that the stock is now worth $10 because the company can't produce mortgage revenue anymore.

Yes, mortgage originations have been struggling and with that, related revenues are declining at all of the big banks. However, would you say that Coke (NYSE:KO) wasn't a buy if a product that produces 1.2% of its revenue began to dip? I doubt it as it would be dismissed, as it should be, as immaterial.

Even if BAC produces zero production revenue for the rest of the year you are talking about 1.2% of the company's top line disappearing, a number most investors likely wouldn't notice. So before you run for the hills on BAC shares due to its lack of production revenue, please consider the scale of this problem. Honestly, there are a lot more important things going on at BAC than production revenue and investors would do well to ignore this piece of the bear thesis and focus on those items that actually make a difference.

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.