Bank Of America's Earnings Are Insufficient To Counter Regulatory And Litigation Uncertainty

| About: Bank of (BAC)

Summary

Bank of America reported mixed results that included declining revenues and mortgage originations, while fixed income revenue was superior to its peers.

The bank's probable Department of Justice settlement in the second half of 2014 adds uncertainty, with a likely valuation between $12-17 billion.

The bank may also suffer from the $4 billion error that forced it to suspend a planned dividend increase and share repurchase plan, which it resubmitted to the Federal Reserve.

On July 16, Bank of America Corp (NYSE:BAC), the second-largest U.S. bank based upon assets, reported a 43 percent decline to second-quarter profit, largely due to declining mortgage revenue and increasing litigation costs. Moreover, the bank is yet to resolve the Department of Justice investigation into its sale of mortgage-backed bonds, which appears likely to result in somewhere further costs of between $12 and 17 billion later this year.

Earnings attributable to shareholders came in at $2.04 billion, or $0.19 per share, compared to $3.58 billion, or $0.32 cents per share, a year earlier. The quarter's litigation expenses were $4 billion. Bank of America's revenue fell to $21.7 billion from $22.7 billion in Q2 of 2013, while operating expenses increased to $18.54 billion from $16.1 billion.

The bank's real estate services business continued to be a drag on earnings, though primarily due to litigation costs associated with its pre-existing liabilities. The unit posted a quarterly loss of $2.8 billion, compared to a loss of $930 million in Q2 of 2013. In terms of continuing operations, the bank made $13.7 billion in home loans in the quarter, which was nearly a 50 percent decline from last year. First mortgage originations fell by nearly 60 percent.

A bright note could be seen in Bank of America's bond trading revenue, which increased by five percent to $2.4 billion, excluding an accounting adjustment. This was a considerably better performance than JP Morgan Chase (NYSE:JPM), whose fixed income trading revenue fell by about 15 percent, or Citigroup (NYSE:C), whose fixed income trading revenue declined by about 12 percent.

In January, Bank of America reported results that were broadly taken as extremely positive, though there was a noticeable amount of financial engineering that clouded the results. The bank then reported Q4 2013 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. These numbers included the bank's withdrawal of $1.246 billion in loan-loss reserves, which roughly equaled one-third of the banks reported income, and results also benefited from an unusually low tax rate of 10.6 percent, compared to BAC's historic average rate of about 25 percent.

The market did not take notice of that financial engineering and instead reacted primarily to the top and bottom line numbers, which appeared good, trusting in the bank to continue on was perceived as a better than average path. This perception was at least partially damaged when in April, the bank suspended plans to increase its dividend and share repurchase plan after an error in its stress-test submission to the Federal Reserve was identified. The error inflated BAC's capital levels by $4 billion and caused it to suspend its plan to raise the dividend to $0.05 a share from $0.01 and to buy back $4 billion in stock. On May 27, the bank resubmitted its requested capital actions, which the Federal Reserve has up to 75 days to review.

Despite the apparent uncertainty that was baked into those Q4 2013 numbers, investors looked at the results through rose colored glasses into April, when Bank of America suspended plans to boost its dividend and share repurchases due to adjustments to its capital ratios. The bank subsequently reported that it discovered an error in its stress-test submission to the Federal Reserve that inflated capital levels by $4 billion due to its inclusion of certain structured notes it acquired through the 2009 acquisition of Merrill Lynch. The bank acknowledged that it had incorrectly accounted for these notes, which had matured or were redeemed after the acquisition.

This current mediocre earnings report is not likely to help lift Bank of America shares out of their most recent funk. This is especially the case while the bank is still yet to settle its mortgage-backed liability Department of Justice, which is expected to be substantial ($12-17 billion), and investors continue to scratch their heads on the status of the suspended dividend increase and share repurchase plans. A related concern may be potentially heightened stress-test scrutiny, or even punishment, due to fall-out from the above-mentioned accounting irregularity. Until Bank of America receives a response from the Federal Reserve and settles the DOJ investigation, heightened uncertainty appears likely to remain a detriment to share valuation.

Disclosure: The author is long C. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.