BOA Maintains Solid Second Quarter Numbers

Bank of America BAC reported net income of $4 billion, or $0.32 per diluted share, for the second quarter of 2013. The results were ahead of ¬†expectations as the pace of change was faster than expected; however, the magnitude of improvements is not likely to result in a substantial increase ¬†fair value. That said, Bank of America’s progress is encouraging and could result in fair value increases if it continues. Most importantly, ¬†compensation expense declined approximately 5% from the first quarter when the effects of stock-based compensation charges are excluded from the calculation. However, much of the improvement appears to be related to the Legacy Assets & Servicing segment, where 5,000 employees left the company during the quarter.

Most other recurring cash expenses were relatively flat during the quarter, in line with expectations, though litigation expenses dropped significantly from the adjusted first-quarter figure, to $500 million. Bank of America’s rating is predicated on expense advantages, so it should be reassuring for investors to see these advantages returning. Other legacy issues are also fading in importance. Bank of America is now in an excellent capital position, with an internally estimated Basel III Tier 1 common ratio of 9.6%.

Management also believes the company is essentially in compliance with newly increased leverage requirements. The resolution of Bank of America’s mortgage exposure is also contributing to our more favorable view of the bank. New representations and warranties claims totaled only $1.3 billion during the quarter, compared with more than $8.2 billion a year ago, and the bank has reserved for outstanding balances at a level that we believe is sufficient to cover its liabilities under most scenarios.

We also note that our current valuation incorporates a significant rise in net interest income over the course of our five-year forecast. Unfortunately, Bank of America’s net interest income declined during the quarter in part because of lower consumer loan balances and yields. As a domestic consumer-focused bank, Bank of America could continue to have problems growing loans and revenue, countering our renewed optimism on the cost front. Bank of America’s wealth and investment management segment recorded record income during the quarter, benefiting from a rising market and inflows into long-term products. We are wary of extrapolating performance during a quarter in which equities recorded all-time highs, especially when assets under management remained flat. Finally, Bank of America repurchased $1 billion in stock during the quarter (in addition to the previously announced redemption of $5.5 billion in preferred shares). While this buyback did not create much value for the $150 billion market cap company, the ability to return–rather than raise– capital is yet another welcome sign that Bank of America is back in the ballgame.

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