In this research note, we'll cover Bank of America's (BAC) third quarter, update the recommendation and discuss recent economic data points.
In the third quarter of 2012, total interest income declined from $13.99 billion in the second quarter to $13.98 billion. Total interest income in the first quarter of 2012 was $15.46 billion. Interest income from loans and leases is trending lower. Interest income from debt securities is up from a year ago. Interest income from debt securities was $1.73 billion in 2011's third quarter and increased to $2.03 billion in 2012's third quarter.
Net income in 2012's third quarter declined substantially compared to the year-ago quarter. Net income declined to $340 million from $6.23 billion. The decline in net income is attributable to a decline in total non-interest income.
The decline in total non-interest income is mostly attributable to a decline in other income. Non-interest income is trending lower. The account declined from $17.96 billion in 2011's third quarter to $10.49 billion in 2012's third quarter. Non-interest income was $12.42 billion in the second quarter of 2012.
Bank of America's non-interest expense is relatively stable while non-interest income declined. The result is a substantial decline in net income. Bank of America will probably continue to decrease its personnel expense. The real issue is the decline in non-interest income. Common shareholders received a loss of $33 million in the third quarter.
However, comprehensive income was $3.03 billion in 2012's third quarter. That compares with $3.37 billion in 2011's third quarter and $3.96 billion in 2012's second quarter. The comprehensive income was mostly attributable to $2.37 billion in net change of available-for-sale securities. Total equity continued to increase in the third quarter.
Financial leverage continued to decline and return on equity declined. Return on equity measures the effectivness of management.
Bank of America's Operating Segments
Bank of America's revenue from almost every operating segment is trending lower. The segments with revenue trending higher are global banking revenue and global wealth and investment management revenue. However, global wealth and investment management revenue peaked in 2011 and has since been trending lower. Global markets was one of the largest operating segments by revenue and is now one of the smallest. Revenue from consumer and business banking fell off of a cliff.
Based on the revenue from the operating segments, Bank of America hasn't turned the corner following the financial crisis. Investors should still be cautious about the future of Bank of America.
Valuations & Financial Performance
I estimated Bank of America's intrinsic value to be $10.29 using a present value dividend discount model. The model assumes the dividend isn't increased in the next year. At $9.51, Bank of America is approaching fairly valued, although, it is still moderately undervalued. The outlook for Bank of America is improved, but the operating segments need to show improving revenue trends.
Operating cash flow and net income declined between 2008 and 2011. That said, the firm has a large pile of cash. I would like to see the profit margin improve: Bank of America has one of the lowest net profit margins of the large financial institutions. Further, the firm has a low financial leverage ratio as a result the firm isn't generating a modest return on capital. Also, based on the recent price-sales levels the firm is probably short-term overvalued.
The consumer price index for all Urban Consumers increased 0.6 percent in September on a seasonally adjusted basis, the U.S. Bureau of Labor Statistics reported today. Over the last 12 months, the all items index increased 2.0 percent before seasonal adjustment. Over the last 12 months, the all items less food and energy index increased 2.0 percent before seasonal adjustment.
Consumer prices' pace of increase excluding food and energy increased to 2.0 percent over the last 12 months compared to 1.9 percent reported last month. Consumer prices' pace of increase is with the FOMC's comfort zone. Expect continued dovish monetary policy.
Foreign Capital Attracted to U.S. Assets
In August the monthly net TIC inflow was $91.4 billion. That compares with $74 billion in July, $14.1 billion in June and $104.3 billion in May. Through the 12 months including August 2011, net TIC inflow was $478.2. Through the 12 months including August 2012, net TIC inflow was $526.4.
There is a net inflow of capital into long-term securities, short-term U.S. securities, and banking flows. Foreign capital is primarily attracted to Treasury bonds and notes. The inflow of foreign capital into U.S. Treasury bonds, notes, and bills is bullish for U.S. equities and sovereign debt.
Industrial Production and Industry Capacity Utilization Increase
The total index of industrial production increased 2.8 points in September 2012 compared to September 2011. The index increased 0.4 points compared to August. Business equipment and construction increased the most compared to a year ago, 10.9 and 4.7 points respectively.
Total industry capacity utilization increased 1.4 points in September 2012 compared to September 2011. The gauge increased 0.3 points compared to August. Mining and utilities led year-over-year gains, 2.0 and 2.3 points respectively.
The industrial production and industry capacity utilization numbers are bullish for U.S. equities. However, the numbers may be near-term peaking.
The third quarter was disappointing. The net income numbers were horrible. Bank of America lacks the ability to adjust operating expenses to meet operating income. The decline in operating income isn't a one quarter event, it is a trend. The operating segment financial performance on a revenue basis isn't good. The short-term valuation may be a bit extended.
While the economic data is improving, Bank of America's operations aren't. I maintain a neutral rating for investors. Traders can look for opportunities to short-sell shares of Bank of America.
Disclaimer: This article is not meant to establish or continue an investment advisory relationship. Before investing, readers should consult their financial advisor. Christopher Grosvenor does not know your financial situation and ability to bear risk and thus his opinions may not be suitable for all investors.
Disclosure: I am short SPY.