Even a Profitable BofA Shows Banking’s Risks

by Dan Burrows | July 18, 2012 12:16 pm

The nation’s biggest banks are doing their part this earnings season to keep the market’s growth rate in positive territory. But business is hardly going gangbusters, and with the economy slowing, plenty could still go wrong.

Bank of America (NYSE:BAC[1]), the country’s second-biggest bank after JPMorgan Chase[2] (NYSE:JPM[3]), swung to a second-quarter profit and beat Wall Street estimates by three cents a share, according to a survey by FactSet.

Thank goodness — even if the way BofA hit the numbers wasn’t all that pretty.

Everyone knew that BofA would return to profitability because of an absurdly easy year-ago comparison. The bank posted a loss of 90 cents a share in last year’s second quarter after accounting for an $8.5 billion mortgage lawsuit settlement.

Therefore, BofA was forecast to be the only thing keeping the S&P 500’s earnings from posting a year-over-year decline[4]. Strip out the bank’s results, and S&P 500 profits were expected to slip nearly 2%.

And BofA isn’t exactly alone. Thanks to a poor period last year, banks as a group are having the highest quarterly earnings growth of any market sector in the second quarter of 2012.

But take it all with a grain of salt. It’s a messy picture when it comes to bank earnings, and as BofA illustrates, it’s also one of incremental improvement.

Like Wells Fargo (NYSE:WFC[5]), Citigroup (NYSE:C[6]) and JPM in earlier reports, BofA benefited from more borrowers paying their loans on time. Indeed, the cash the bank set aside to cover bad loans dropped 46% over last year’s quarter to hit $1.8 billion. That’s a lot of money, to be sure, but it’s also the lowest figure BofA has booked since early 2007, or before the financial crisis hit.

And, like the broader industry, BofA generated more revenue from its mortgage business. As was especially evident in WFC’s results[7], more people are taking out mortgages or refinancing[8] these days, and that’s been a bright spot for the banks.

However, unlike its peers, BofA’s mortgage business still lost money, as it takes hits on the portfolio of dodgy and exotic mortgages held by its Countrywide unit. Still, as BofA and other banks illustrate, the wider recovery in the housing market may be tepid[9], but the trend of muddling along is real — and  far better than further deterioration.

More troubling is that BofA’s revenue missed Street estimates, despite jumping 66%. And, unlike rivals, it didn’t enjoy the same pickup in loan activity. By comparison, JPM, WFC and C all posted slight increase in total loans.

Furthermore, BofA fell victim to something no bank has escaped, not even vaunted Goldman Sachs (NYSE:GS[10]), as investment banking was slammed[11] by a lack of deal activity and new issuance of stocks and bonds. Sales and trading revenue likewise declined, as customers still have no appetite for churning risky stocks.

All in all, the nation’s banks are healthier, and the worst seems to be behind them — but they’re all struggling to find new sources of revenue amid a tougher regulatory environment.

And they are all looking to cut costs.

The picture is brighter than it has been in a long time, but as BofA shows, the banks still have a way to go. JPM has it’s trading loss to clean up[12]. WFC is highly dependent on continued recovery in housing[13]. And Citi, with its sprawling international business, may be too big to grow[14].

A sluggish U.S. economy and the European debt crisis mean BofA and financial sector stocks still have plenty of downside risks in the weeks and months to come.

As of this writing, Dan Burrows held none of the securities mentioned here.

  1. BAC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BAC
  2. second-biggest bank after JPMorgan Chase: https://investorplace.com/2012/07/jpmorgan-has-a-cold-not-pneumonia/
  3. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  4. a year-over-year decline: https://investorplace.com/2012/07/bracing-for-an-ugly-earnings-season/
  5. WFC: http://studio-5.financialcontent.com/investplace/quote?Symbol=WFC
  6. C: http://studio-5.financialcontent.com/investplace/quote?Symbol=C
  7. WFC’s results: https://investorplace.com/2012/07/wells-fargo-wfc-profit-shows-housing-on-the-mend/
  8. taking out mortgages or refinancing: https://investorplace.com/2012/07/refinance-now/
  9. recovery in the housing market may be tepid: https://investorplace.com/2012/07/the-ho-hum-truth-about-the-housing-market/
  10. GS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GS
  11. investment banking was slammed: https://investorplace.com/2012/07/should-i-buy-goldman-sachs-3-pros-3-cons/
  12. trading loss to clean up: https://investorplace.com/2012/07/jpmorgan-has-a-cold-not-pneumonia/
  13. dependent on continued recovery in housing: https://investorplace.com/2012/07/wells-fargo-wfc-profit-shows-housing-on-the-mend/
  14. may be too big to grow: https://investorplace.com/2012/07/citigroup-too-big-to-grow/

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