- Bank of America's estimates were cut earlier this week on old information.
- The reasons cited by KBW are unfounded or priced into shares already.
- Investors ignored KBW's note and sent shares up 2% instead.
KBW, in its infinite wisdom, cut earnings estimates at JPMorgan (NYSE:JPM) and Bank of America (NYSE:BAC) yesterday. KBW cut the House of Dimon on the slowdown in trading activity it reported for the quarter, lowering full-year EPS by a whopping 14 cents, or 2.4%. In BAC's case, estimates were lowered from $1 to 90 cents for 2014 on the same trading slowdown, the suspension of the buyback due to BAC's capital miscalculation and litigation costs. Where have these guys been? Let's take a quick look at the BAC estimate cut.
First off, the trading slowdown has been well-publicized. JPMorgan warned recently that FICC revenue was going to be down and Mr. Market took that news and ran with it. Every bank in the country that derives any significant portion of its revenue was sent tumbling on the news, BAC included. However, virtually any kind of trading has cyclicality inherent to the business and FICC is no different. Even Dimon said he didn't believe this was a structural slowdown in trading revenue and that it is simply a bump in the road. So why is BAC being lumped in with JPM when it hasn't warned on its trading revenue? Maybe BAC's FICC revenue will tank along with JPM but right now, it's being assumed that is what is happening. Thus, I think this provides the potential for some upside surprise. JPM's FICC revenue is going to be weak, as they reported, but BAC has made no such report and since shares have already been punished for something that hasn't happened, we could be looking at some upside if actual results are even moderately positive. But even if results are terrible, it's already been priced in.
Second, the capital miscalculation has been blown way out of proportion. I keep hearing it called an "accounting error" when that is not the case. Accounting errors affect the company's earnings or book value; this was a capital miscalculation for the purpose of the stress test. It did not affect the company's earnings, its ability to pay its bills or anything else; it was strictly for the purpose of calculation capital for risk scenarios. Missing an extremely complex security that was inherited from an ill-conceived merger doesn't mean the company has no risk controls or that the bank is a house of cards built on false numbers. It was a simple mistake and the fact that shares got absolutely hammered on the news is proof investors don't even understand what happened. I bought more when shares were trounced on the miscalculation news because it isn't real news; BAC's internal controls are fine and sending shares down like it has accounting issues is just stupid.
Finally, KBW is late to the party piling on about litigation issues. KBW reckons that BAC's litigation issues will continue to deteriorate earnings in 2014 but as BAC reported recently, litigation issues are subsiding. According to BAC's best information, litigation issues are apparently passing because it reduced the estimate of litigation liabilities over and above reserves by over a billion dollars. Given that BAC has paid something like $50 billion in litigation claims over the past few years, depending on who you ask, a billion dollars doesn't seem like that much money. However, that is 10 cents of EPS (roughly) and, more importantly, it signals that the worst is likely behind BAC in terms of litigation liabilities if it is willing to publicly say liabilities have been reduced. I think KBW has gotten this one wrong as it is using old information to make an EPS cut.
In short, I'm glad I'm not paying for KBW's "research" because I think their points for cutting EPS are either unfounded or already well-known public information. Yes, the trading slowdown is potentially worrisome, yes, the buyback suspension is a temporary headwind, and yes, litigation expenses are still elevated. However, all of these things are known and in the case of all three, are already priced into shares. I suspect that is why investors completely ignored KBW's note yesterday and instead sent shares up 2%. The bottom line is KBW's "news" is already priced into shares, leaving ample room for an upside surprise if BAC's financials don't come crashing down like investors are forecasting.