Bank of America Earnings – Behind The Headlines

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Oh, Bank of America (NYSE: BAC), just when it looks like things could be looking up, you report earnings. On the surface, the numbers were not that good, and below the surface there are some downright scary things happening. I've written before about how buying Bank of America could be a good idea. Based on reading through the most recent earnings report, I've changed my mind. 

There are a few positives in the report. First, this company is expected to earn $0.62 in 2012, which gives the stock a forward P/E ratio of 12.25 -- while this isn't a huge bargain, it's not terribly expensive. Also analysts expect earnings in 2013 to come in at $1.05. That means on 2013 earnings you can buy Bank of America for 7.24 times 2013 projections. That sounds much better.

Second, the company has managed to improve its balance sheet. Its equity-to-assets ratio is about as high as it has been at 9.98. On a year-over-year basis, allowance for loan losses was down 19.34%, non-performing loans were down 15.17%, and net charge-offs were down 39.32%. Those numbers sound like Bank of America is making progress. The company also announced that they are going to be cutting positions and those cuts should save about $5 billion per year in expenses.

So what's the problem? Investors have other choices that just plain look better. While Bank of America sells for 12.25 times 2012 earnings, you can buy Wells Fargo (NYSE: WFC) for about 10 times forward earnings. The fact that Wells pays a dividend of 2.64% versus Bank of America's 0.52%, is another factor that argues for buying Wells instead. There are other problems that Bank of America has to own.

Line Items:

To be blunt, of the six major line items that Bank of America reports on, only one showed actual growth. Look at the numbers:

<table> <tbody> <tr> <td> <p><strong>Line Item</strong></p> </td> <td> <p><strong>Non-Interest Income</strong></p> </td> <td> <p><strong>Consumer & Business Banking</strong></p> </td> <td> <p><strong>Global Banking</strong></p> </td> <td> <p><strong>Global Markets</strong></p> </td> <td> <p><strong>Global Wealth & Investment</strong></p> </td> </tr> <tr> <td> <p>Income</p> </td> <td> <p>Down $9.9 bil.</p> </td> <td> <p>*Up 56%</p> </td> <td> <p>Down 23.64%</p> </td> <td> <p>Down 76.8%</p> </td> <td> <p>Up 23.58%</p> </td> </tr> </tbody> </table>

(* adjusted for $10.4 billion goodwill impairment charge) 

You can see that except for Global Wealth & Investment each division had its challenges. In fact, the only other division that showed higher income is somewhat smoke & mirrors. Consumer & Business Banking showed an increase of 56% in income. This is great, right? Wrong, this 56% increase still means a $3 billion loss. While these other divisions might improve in the future, there is one division that should be a huge concern for investors. That division is Consumer Real Estate Services, and the numbers here aren't for the faint of heart.

Consumer Real Estate Services:

This division is the reason to stay away from the company. The headline numbers are terrible, and are likely to be that way for a while. A 130% drop in revenue and a 119% drop in net income is what investors know about. That doesn't tell half the story. You have to read through about 60 pages of earnings report to get some of these numbers you'll see.

Residential Mortgage:

Bank of America blamed lower mortgage income on lower demand. While demand for mortgages was down 17% in 2011, the company's first mortgage production though was down over 50%. The company said it expects to lose market share in the mortgage industry as they have exited the correspondent channel. The mortgage portfolio's quality is terrible. While non-performers were down 9.72% in residential mortgage, the trend in other past due loans says this percentage will move up in the future. Loans 30 days past due increased to 10.94% from 9.4% last year. Loans 90 days past due increased to 8.07% from 6.5%. Some of the other truly scary numbers are 33% of the portfolio has a LTV over 100%. Customers that have a FICO score of 620 or less represent 21% of the portfolio. Now my favorite statistic: 40% of the residential mortgage portfolio are interest-only loans. This means we don't know if 40% of the company's mortgages are affordable as those borrowers haven't had a fully amortized payment.

Countrywide Portfolio:

The Countrywide portfolio's numbers are even worse if that's possible. Of this portfolio, 36% of the loans are 180 days past due or more. As a former banker myself, let me just say, write them off, they are not coming back. This represents $12.7 billion of potential losses for the company. Another 7% of this portfolio are in early stage delinquency. Countrywide loans with an LTV over 90% represent 62% of out-standings. That is a huge percentage, and without some government program they are effectively locked out of refinancing. There are very few banks that will take a loan over 80% combined LTV much less 90%.

Home Equity:

Last but not least, the Home Equity portfolio shows 78% are home equity lines of credit at interest-only. This is another situation where the inevitable higher interest rates in coming years, will cause higher payments. In addition, 36% of the home equity portfolio has an LTV over 100%. These customers have virtually no chance of refinancing their home equity. This means some of these home equity line customers are both on interest-only and their LTV is over 100%. If rates start to rise, they might look to refinance only to find that their high LTV won't allow them to.

Conclusion:

As you can see there are big problems beneath the surface at Bank of America. If you want to avoid all of these issues, I would suggest a large bank that is less well known. Take a look at BB&T (NYSE: BBT). While Bank of America grew deposits by about 2%, BB&T grew deposits in the last year by about 18%. While Bank of America shows loan runoff of about 1.5%, BB&T is taking some of these loans by growing their portfolio by 13.36% in the last full year. You can buy BB&T with much better organic growth for about 11.85 times 2012 estimates. At this point, I just don't see a good reason to buy BAC until the company's loan issues start to turn around. Based on their 30 and 90 day delinquencies, and their high LTV issues, that could take a while.


MHenage has no positions in the stocks mentioned above. The Motley Fool owns shares of Bank of America and Wells Fargo & Company and has the following options: short APR 2012 $21.00 puts on Wells Fargo & Company, short APR 2012 $29.00 calls on Wells Fargo & Company, short OCT 2012 $33.00 puts on Wells Fargo & Company, and short OCT 2012 $36.00 calls on Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus