Bank Of America: A Story Of Cheap Valuations And Rising Litigation Expenses

| About: Bank of (BAC)

Bank of America (NYSE:BAC) has shown tremendous growth in the past. The stock is attractively valued when compared to most of its peers in the U.S. banking industry. However, the bank is still burdened with litigation. These litigation expenses have the potential to put significant downward pressure on earnings in the coming quarters. Therefore, we are not recommending that investors buy the stock.

Surprises History:

The table below shows how BAC has been beating revenue and EPS estimates. The average quarterly earnings surprise comes out to be a significant 42%, while the average quarterly surprise is an insignificant 0.6%.

Source: Yahoo Finance

For the most recent quarter (second quarter of the current year), the bank posted an earnings figure that surpassed its consensus estimate by over 7%, while revenues for the same quarter remained in line with expectations. Much of this positive surprise in earnings was associated with the bank's successful cost-cutting initiatives.

Recent Quarter's Performance:

Compared to a loss of $8.8 billion in the second quarter of the current year, the bank posted a profit of $2.5 billion in the second quarter of the current year. The bank generated a turnover of $22.2 billion against $13.5 billion in the same period of the prior year.

Much of the improvement in the turnover came as a result of a five-fold YoY increase in the income that the bank generated from non-interest sources. The bank collected $12.4 billion in fees and other related activities at the end of the second quarter of the current year; a year ago it was $1.9 billion. Fee-based income grew largely on contribution net gains on repurchases of certain debt and trust-preferred securities.

Interest income dropped from $11.5 billion to $9.7 billion. Lower consumer loan balances and decreased investment securities yields were propounded as the primary reasons for this decline in interest income.

Credit loss provisions decreased by $1.5 billion to $1.8 billion. The improvement in provisions was associated with lower credit costs in residential mortgage loans portfolios and home equity. The bank witnessed a decline of $5.8 billion in its non-interest expense, which is now $17 billion.

Segmental Performance:

For the purpose of reporting, the bank's operations are divided into five segments; Consumer & Business Banking, Consumer Real Estate Services, Global Banking, Global Markets, and Global Wealth & Investment Management.

The Consumer & Business Banking segment saw a decline in its revenues and earnings when compared to the same period of the previous quarter. Much of the decline in the performance of the segment was associated with the decline in net interest income, which was due to lower average loans and yields. The segment was clearly affected by the prolonged low interest rate environment.

The Consumer Real Estate Services segment incurred losses in the second quarter of the current year. However, the losses shrunk when compared to the same quarter of the previous year. The improvement from the previous year was primarily associated with lower representations and warranties' provision, higher servicing income, and lower non-interest expense.

The Global Banking segment saw a decline in both revenues and earnings. Much of the decline in performance was associated with lower investment banking fees.

The Global Markets segment also saw a decline in both the top and bottom lines. The decline was largely due to lower trading and sales revenues, which resulted due to lower client flows and trading volumes.

The Global Wealth & Investment Management segment witnessed a decline in revenues. However, the bottom line surged by 5.8% YoY. Lower non-interest expense due to lower Federal Deposit Insurance Corporation (FDIC) expense is thought to be the primary reason.

Loans and Deposits:

Total loans and leases at the end of the second quarter of the current year shrunk by 3.6% with respect to the same quarter of the previous year, while total assets improved by 1.5% over the same period. Total deposit improved by 29 basis points when compared to the previous year.

Capital Position:

The bank is considered to have robust capital. This is reflected by its Tier 1 common and Tier 1 capital ratios of 11.24% and 13.8%, respectively, as compared to 10% and 11.7% for Wells Fargo (NYSE:WFC).

Exposure to Europe:

According to the SEC filings, the bank's net country exposure towards GIIPS nations (Greece, Italy, Ireland, Portugal and Spain) was $9.6 billion. The exposure declined by $726 million, as compared to the last quarter of the current year. Competitively, the net funded credit exposure to GIIPS nations for Citigroup (NYSE:C) was $6 billion at the end of the second quarter of the current year.

Recent Events:

As previously noted, Bank of America is burdened with litigation charges. On September 28, 2012, the bank announced that it will make a payment of $2.43 billion to settle a class action law suit, which dates back to 2009. A combination of the bank's existing litigation reserves, and litigation expenses to be recorded in the third quarter of the current year, will cover the cost of the proposed settlement. According to the bank's own estimates, $1.6 billion of expenses will be recorded in the third quarter of the current year. This litigation expense is considered to burden the earnings per share of the third quarter by around $0.28. An early resolution of the litigation expense is in the best interest of the bank's shareholders, as it will remove risk and uncertainty regarding the bank's future.


Bank of America's stock trades at a discount of 56% to its book value. In contrast, Citigroup trades at a discount of 48%, while Wells Fargo trades at a premium of 34%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Financial Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.

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