Is Bank of America in Position to Rebound?
Helen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Bank of America (NYSE: BAC) has reported better than expected results for the first quarter of 2012 because of the recovery on Wall Street and lower losses in their consumer credit businesses. The results demonstrate the dependence of Bank of America on profits from bonds, commodity and currency trading as Wall Street remained buoyant and despite the capital market uncertainties in Europe. Income from its traditional businesses of consumer and business banking fell by more than 30%. Brian T. Moynihan, the chief executive, has focused single-mindedly on improving the capital position even if it means that Bank of America has lost its position as the largest American bank by assets to JPMorgan Chase (NYSE: JPM) and as the largest servicer of mortgages to Wells Fargo (NYSE: WFC). It is obviously doing its best to slim down and cut back on costs as is evidenced by the reduction in the number of branches as well as the head count
Net income dropped to $653 million or three cents a share from $2 billion or $.17 a share from the same quarter of the previous year. I should however point out there were a number of complicated one-time accounting adjustments which make it difficult to get a proper fix on the strength of the underlying business. Accounting related issues, primarily relating to the valuation of debt reduced profits by almost $5 billion. Excluding these one time charges, Bank of America performed well with an increase of almost 40% to $3.6 billion in operating profits on revenues that were down by more than 2% to $27.3 billion. Profits at the global wealth and investment division which includes Merrill Lynch were more than double the profits of the preceding quarter.
The bank has a number of mortgage related issues that still worry investors. Some investors who have invested in mortgages that went sour have been trying to get the bank to buy them back on the grounds that they were not underwritten correctly. There are also ongoing disputes with Fannie Mae and mortgage repurchase claims from government-sponsored entities are up almost $2 billion from the previous quarter. It should however be noted that Bank of America has created results of almost $16 billion for these claims. Investors who had been worried about the effect of these claims on the bank's capital position would have been pleasantly surprised by the increase in the Tier 1 capital ratio to 10.78% from 8.64% in the previous year. Loan commitments dropped by 4% to $902 billion as an increase is shown by both JPMorgan and Wells Fargo. The signs of the upturn in the economy were reflected in the reduced loan loss provisions for consumer loans from $3.8 billion to $2.4 billion as customers stayed current on all categories of loans.
Earlier, the bank had passed a Federal Reserve stress test that showed that progress had been made in the improvement of capital levels of American banks that were troubled. However, the conservatism of the second largest bank in the United States helped in contrast with some other banks, most notably Citigroup, that saw the Fed decline proposals for share buybacks and dividend increases. It is worth noting that Bank of America proposes to do neither and continue to build capital instead. The better quality banks such as JPMorgan Chase & Co as well as Wells Fargo were allowed to proceed with share buybacks as well as dividend increases. The stress test used highly stringent criteria such as an unemployment rate in the United States of 13%.
Despite the troubles of the last few years, it appears that a number of factors are combining to enable investors to benefit from the banking sector and Bank of America in particular. The US dollar is expected to continue to show a depreciating trend and this should result in price inflation. Bank balance sheets are heavy on assets and they should be the first to benefit from this inflation. Because of the high degree of leverage, this appreciation would be magnified. Moreover, money has never been cheaper and investors are willing to settle for low yields. This enables banks to raise money cheaply by using CDs and then reinvest the money in high-yield assets. Wall Street is likely to continue to be volatile and this can lead to high profitability with the use of the right trading strategy. Finally, it does appear that banks such as Bank of America are too large and important to the continued health of the economy to be allowed to fail. Bank stocks have lagged the market and it is time that they received the investing interest that they deserve.
If you take a good look at its peers such as JPMorgan Chase, Wells Fargo, Citigroup and Morgan Stanley, you will see that Bank of America is the cheapest of this group. Since you should not invest in stocks that you do not fully understand, you should learn a little more about the accounting adjustments that depressed the bank's results for the first quarter especially the adjustment in the value of debt. In the bad times of the past few years, bank debt decreased in value and banks attempted to capitalize on this decrease by showing it as revenue. Now the boot is on the other foot and increases in value have to necessarily be shown as losses. In my opinion, these are academic adjustments that have no impact on operating profitability because banks are not in a position to trade actively in their own debt. After all, you need to cash in on the reduction in value by buying back and refinancing at low rates.
Bank stocks, in my opinion, have touched rock bottom and are beginning to rebound. If you are extremely selective about your investment, you should be able to profit from the rebound. Even if you are a conservative investor, you should hold on to your existing investment in Bank of America stock and watch the developments. You have an extremely limited downside and the opportunity to profit from favorable developments.
QueenBC has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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.
