Say what you will about the quality of sell-side research these days, but scanning reports can at least give you a sense of how one side of the Street feels about a company. To that end, I'm a little surprised at the generally positive response to Bank of America's (NYSE:BAC) second quarter earnings. While it is true that credit and capital are slowly getting better, I see a lot of "core" issues that make me question the pace and extent of the bank's ultimate recovery.
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A Lot of Scary Numbers This Time Around
Bank of America reported a 10% sequential decline in operating revenue, with net interest income down about 11% on a 30 basis point decline in net interest margin. Fee income was also unimpressive, declining 9% sequentially despite solid performance in cards and mortgage banking. While the results from JPMorgan (NYSE:JPM) and Citigroup (NYSE:C) made it pretty clear that this was not going to be a good quarter in investment banking, the 36% sequential decline in sales and trading was still pretty uninspiring.
While loan performance at large banks like Wells Fargo (NYSE:WFC), JP Morgan and Citi have been pretty iffy ((U.S. Bancorp (NYSE:USB) is an outlier in that respect so far)), Bank of America saw a 1% decline, with weakness in mortgage, card and commercial real estate. Although Bank of America has a long history of being a major player in mortgages, it looks like the company is losing ground to Wells Fargo, JP Morgan, U.S. Bancorp and others.
SEE: The Banking Industry In 2012
Credit quality was once again mixed. Reported non-performing asset and net charge-off ratios improved, but are still higher than those of most peers. What's more, the company saw another repurchase provision of nearly $400 million and saw claims leap to nearly $23 billion. Even if these claims are inflated (as management seems to suggest), it represents about 10% of shareholder equity and that's too large to just ignore.
What's the Real "Core"
I would suggest that America's prisons ought to consider forcing white collar criminals to read Bank of America earnings statements and then write reports on the statements; the company has a lot going on and has a duty to report it to shareholders, but it doesn't make for light reading.
SEE: Earnings Quality: Defining "Good Quality"
Because of all of the noise at Bank of America, analysts try to talk about the bank in terms of its "core" performance. For instance, many analysts try to downplay DVAs and focus on items like lower provisions and litigation charges to make the case that core performance at Bank of America is getting better.
That's fair enough, but I do worry about the company's loan weakness and shrinking deposits. While the FDIC deposit share data is unfortunately not really "real time" information, it looks like Bank of America is seeing erosion - both to large banks like U.S. Bancorp and JP Morgan, but to smaller regional and community players as well. My fear, then, is that all of the asset sales that Bank of America has had to do to shore up capital and all of the focus on the balance sheet may have meaningfully undermined the bank's core banking competitiveness.
SEE: Who Backs Up The FDIC?
The Bottom Line
The good news, such as it is, is that Bank of America continues to trade at a discount to tangible book value and one need only assume high single-digit returns on equity in the future to produce a reasonably attractive price target. I'd still advise caution though; while I have no doubt that a recovery in Bank of America could indeed reward patient shareholders, I'm still not certain that such a recovery is in the bag.
At the time of writing, Stephen D. Simpson has owned shares of JP Morgan (JPM) since January of 2006.