Bank of America Earnings Preview
Bank of America (NYSE: BAC) stock rose in intraday trading on Wednesday as investors digest Goldman Sachs's results and anticipate growth in Bank of America's earnings. Last quarter the company beat earnings estimates, which temporarily lifted stocks above $7 per share, only for shares to fall to a 52-week low in December after Fitch Ratings cut its rating of Bank of America in addition to other commercial and investment banks amid lower investment banking performance thanks to decreased trading volumes and failures to tame eurozone bond markets.
This time around, analysts are expecting the bank to maintain profitability thanks in no small part to a plummet in the bank's debt-to-asset ratio to 33.74%. However, the company's figures are expected to fall due to continuing challenges for the banking sector. Analysts are hoping for revenue to stay above the $27 billion mark (down slightly from $28.7 billion on the previous quarter), while the most optimistic see net profits of $5 billion (down from $6.2 billion). According to a Bloomberg survey, analysts are expecting an average pretax profit of just $3.68 billion.
Bank of America's results will come after Wells Fargo (NYSE: WFC) reported strong mortgage performance, which is also expected to rise for Bank of America to over $1.6 billion--an increase of 32%. However, mortgages play a smaller part of Bank of America's total revenue than Wells Fargo, since it is dependent on investment banking operations, which accounted for over $5 billion of the firm's results in Q3 2011. That number is expected to fall below the $5 billion mark, in line with the falling investment banking profits at Goldman Sachs (NYSE: GS) reported on Wednesday.
Another important source of revenue for the company is service charges, which are expected to climb slightly; last quarter, service charges accounted for $2 billion of the bank's total income, a bit shy of double the bank's mortgage revenue. Service charges have been a double-edged sword for the bank, since plans to increase debit card fees gave the bank a black eye last year and fueled simmering disgust with the investment banks after the subprime mortgage crisis hit the global economy, bailouts poured tax dollars into banks, and Occupy Wall Street pointed the finger at the banking sector for the growing income disparity in America. When Bank of America promised to scrap its $5 fee in November, the damage was already done, with Move Your Money reporting that Wall Street banks have lost over 4 million accounts since their campaign began, with another 12 million accounts projected to move to credit unions or community banks in the next two years.
If Bank of America remains dependent on service charges for almost 10% of its revenue, it cannot remain competitive with smaller banks and credit unions, who charge substantially lower fees to individual customers (in some cases, credit unions offer dividends instead).
Bank of America is also being challenged by rising capital requirements. The bank has struggled to keep enough cash on hand to please regulators for quite some time, and the fight isn't over. Lsat year, Bank of America sold assets worth $33 billion to meet the new standards, which has resulted in a lower income. In other words, tougher regulation has forced Bank of America to get smaller, which it did by selling off interests in several foreign markets, such as an interest in China Construction Bank Corp. (HK: 939) at a time when China's lending market remained lucrative. In 2010, the bank sold off another $20 billion.
This loss of assets is going to hurt its profit targets, which have already been cut thanks to a lack of investment banking opportunities combined with the bank's smaller market presence. However, the selloff also helped Bank of America cut its debt load, which has helped its margin slightly by lowering the amount it loses on interest payments. In November, the bank's debt load fell to just shy of $400 billion, and that figure might continue to fall thanks to the bank's more cautious approach.
While 2011 saw the bank contract, this year might see even further, more strategic cuts. In October, Bank of America CEO Brian Moynihan said that the bank was pretty much done selling off name-brand assets, and would turn to focusing on mortgage-servicing contracts and credit card loans. "There are still non-core assets we're getting rid of, but it's loan portfolios, things of less note, and that will take place through the next 12 to 18 months," Moynihan said.
As Wells Fargo's performance demonstrates, now may not be the best time to begin exiting the mortgage market, since it is one of the few banking activities showing health. There are other options. CLSA analyst Mike Mayo suggested that the bank could sell off Merrill Lynch, but it is unlikely that the bank would want to rid itself of the wealth management unit that currently produces $14.8 billion in annual revenue. Much more likely would be a divestment in mortgage operations, which would limit the bank's ability to take advantage of expansion in that sector.
Some analysts have a mutedly optimistic view of Bank of America. With an average profit estimate of 18 cents per share, analysts are expecting a 500% year-on-year earnings increase. This may be partly due to Bank of America beating estimates in the second and third quarters of 2011 after a return to profitability. In 2010, the company lost $7.3 billion, but the stock performed well relative to 2011, when it fell by over 58%.
The paradox of a lowered stock price and rising net profits can be explained as market anxiety over the upcoming Volker Rule, which will restrict how investment banks can trade in the hopes of eliminating conflicts of interest. Certain restrictions, such as prohibiting commercial banks from engaging in proprietary trading or holding an ownership in a hedge fund or equity fund, have worried investors who think that the rules will limit the growth potential of the major banks.
Another looming concern has been the Comprehensive Capital Analysis and Review (CCAR), a stress test that will expand to all 31 banks holding over $50 billion in assets. In early 2011, the Federal Reserve objected to Bank of America's plans to increase its dividend on concerns that the bank was not increasing its capital reserves quickly enough.
With weighing regulatory concerns and shrinking operations, analysts have remained cautious in their earnings estimates. Nonetheless, it seems likely that Bank of America is not going to go back to the dark days of 2009 and 2010 just yet.
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