The basic idea behind accounting is that business owners ought to have some idea of figuring out how their businesses are doing, and that the standards applied should be relatively uniform and consistent. While GAAP accounting works well enough for the most part, it gets tricky with banks and nightmarish when applied to large, complicated money-center banks like Bank of America (BAC). Unfortunately, for all of management's claims about how strong Bank of America is, there are a lot of gaps left in this story.
First Quarter Earnings … If You Can Call Them That
Bank of America reported Thursday morning that operating revenue fell 3% year on year, but rose 3% sequentially to just under $24 billion. Net interest income rose 1% sequentially, helped in large part by a slight bump in net interest margin. Fee income came in much higher, but the numbers were muddy - most items were pretty mediocre, but a huge increase in mortgage banking income swung the balance.
Expenses were up about 3% from the fourth quarter, leading pre-provision net revenue to jump about 60% sequentially (but decline about one-third from last year). Unfortunately, even that last number is subjective as the "core profitability" of these large banks is almost entirely a product of what each analysts chooses (or omits) to add back.
To wit, some analysts are backing out a variety of items (including sizable changes in DVA, structured liabilities, and litigation) and indicating that "core" earnings were above $0.20 a share at Bank of America. While I'm fine with ignoring DVA as a non-operating item, it's important to be consistent from quarter to quarter and I'm not sure that excluding items like litigation makes sense when Bank of America is likely to be in court and/or paying settlements for years to come.
Some Troubling Details
I'm also bothered by some of the other details within Bank of America's report. Net interest margin here was the lowest of the major banks that have reported, though close to JPMorgan's (JPM) level and not that far off from Citigroup (C). Unfortunately, some of the apparent sequential improvement was an artifact of premium amortizations (something relevant at many banks large and small).
I'm also troubled with the trends in credit quality. Not only did the NPA ratio increase (as it did at JPMorgan, Citi, and Wells Fargo (WFC)), but it's still high on an relative basis as well (as is Wells Fargo's). I find it strange, then, that the company took a $1.6 billion loan loss reserve release even though repurchase claims from GSEs and private-label buyers jumped about $4 billion and the bank said that its exposure could be $5 billion or more above its current accruals.
That said, certain areas like commercial real estate and credit cards are getting better (and getting better pretty consistently across the sector), so some of this goes down to which "pot" the reserves are released from in the quarter.
It also bugs me that Bank of America management boasts of a "fortress balance sheet" in its earnings release. I'm not sure what sort of fortress they have in mind, but given the number of parties still lining up to sue Bank of America and the large percentage of loans that could yet go sour (to say nothing of yield compression), I just don't see how anyone could call this a fortress balance sheet.
The Bottom Line
To be fair, almost every bank has some problem (and usually more than one). JPMorgan has big derivatives exposure, a net interest margin that has dropped seven of the last nine quarters, and a recent increase in non-performing loans (the first in a while). Citi's situation isn't much different, Wells Fargo had the same increase in non-performing loans and has an outsized exposure to consumer credit, and U.S. Bancorp (USB) has to deal with a new regulatory environment when it comes to its lucrative fee-based business (though at least its non-performing loans continue to decline).
Still, all animals may be equal but some are more equal than others, and I just don't trust Bank of America at this point. The company may well not need to raise equity capital again (low rates should help its refinancing needs), but I see this bank muddling along for quite some time.
If Bank of America can post an 7.5% return on equity within five years (and then hold it), these shares could be worth close to $10, but I fear that additional write-downs and reserves are likely to chew up more equity before it's all said and done. Still, 7.5% is exceptionally undemanding by the standards of the industry today, so investors who have more confidence in Bank of America's balance sheet may see more value here than I can.