Bank Of America Earnings Preview: Profits To Plunge In 4Q On Legal Charges, Revenue Concerns

Bank of America Corp (NYSE: BAC), still haunted by the legacy of the 2008 financial crisis, is expected to post an 87 percent drop in profits for the fourth quarter of last year as the lender continues to cope with legal problems. For 2012 as a whole, cost-cutting initiatives and sales of unwanted assets at the nation’s second-largest bank by assets likely boosted BofA’s bottom line amid declining revenues.

According to Reuters, analysts who follow Bank of America’s business see the Charlotte, N.C.-based company eking out a profit of 2 cents a share on revenue of $21 billion in the last three months of 2012. In the same period a year earlier, EPS was 15 cents on $24.9 billion in revenue. In the third quarter of last year, Bank of America’s profit dropped 95 percent, breaking even on a per-share basis, and revenue tumbled 28 percent.

Expectations have dropped for Bank of America’s fourth-quarter results in the months leading up to the company’s earnings announcement due at 7 a.m. EST on Thursday, Jan. 17, 2013. Over the past three months, the consensus estimate has moved down from 19 cents.

“While plenty of progress has been made on capital, and expenses should begin to trend lower in the fourth quarter of 2012, Bank of America’s earnings remain muted as loan growth is still sluggish and net interest income remains tethered,” Nomura analyst Glenn Schorr wrote in a report to clients on Oct. 17.

After meeting with Bank of America’s Chief Financial Officer Bruce Thompson, analysts at JPMorgan projected in a Dec. 11 note that BofA’s fourth-quarter trading revenue should be impacted by about 15 percent decline in volumes due to seasonal slowdown in the last two months of 2012 and should be exacerbated last year by concerns about the elections, fiscal cliff and some impact from Hurricane Sandy. In addition, spreads have not tightened appreciably as an offset. Trading revenues will be impacted by new regulations set to take effect in 2013, particularly related to new rules in rates and currencies businesses, although timing has been delayed.

For the fiscal year, analysts are projecting earnings of 24 cents per share on revenue of $86.9 billion, compared with 1 cent a share on revenue of $93.5 billion in the year-ago quarter.

As for the earnings conference call scheduled at 8:30 a.m. EST on Thursday, Morgan Stanley is telling its clients to watch for answers to these questions: status of overall cost-cutting plans, reduction in legacy asset headcount, mortgage settlement with banking regulators, expenses and delinquent mortgages, mortgage servicing asset sale efforts, rate of decline in non-core assets, revenue impact of shrinking expense base, debt footprint outlook, the London interbank offered rate (LIBOR) review, net interest margin (NIM) pressure and offsets.

Bank of America said last week it expects a $2.7 billion reduction in its pretax fourth-quarter earnings from the Fannie Mae settlement and a $2.5 billion negative fourth-quarter impact from the foreclosure settlement and other mortgage-related matters, in addition to existing reserves. Overall, the lender expects these actions to result in “modestly positive” earnings per share in the fourth quarter.

Litigation Woes

Through an aggressive campaign of acquisitions, Bank of America went from a regional player to the largest bank by assets before relinquishing the crown to JPMorgan Chase & Co. (NYSE:JPM) in the third quarter of 2012.

The bank made its two most consequential deals in 2008.

The first one, announced in January, was a $4 billion takeover of Countrywide Financial, a deal which has turned out to be an unmitigated disaster for the bank. Some analysts have pegged its true financial toll — including write-downs, legal expenses and settlements — at more than $40 billion.

Major U.S. banks, including Bank of America, took another step on Jan. 7 to clear away the wreckage of the 2008 financial crisis by agreeing to pay $8.5 billion to settle charges that they wrongfully foreclosed on millions of homeowners. By booking the deal’s cost in their fourth-quarter results, this will enable them to present a cleaner slate to investors in 2013.

In its agreement with the government-controlled mortgage finance company Fannie Mae, Bank of America will pay the agency about $3.6 billion to compensate for faulty mortgages and $6.75 billion to buy back mortgages that could have resulted in future losses for the government.

The banks also sold the rights to collect payments on about $306 billion of home loans to Nationstar Mortgage Holdings Inc (NYSE: NSM) and Walter Investment Management Corp (NYSEAMEX: WAC).

"Through these actions, Bank of America is addressing substantially all of its remaining exposure to repurchase obligations for residential mortgage loans sold directly to Fannie Mae,” Bank of America said in a statement.

While expense reductions will likely take time (and potentially lag revenue losses), over time the announced mortgage sales and the organic run-off in the fourth-quarter of last year should result in $3.4 billion in cost savings, offset by $765 million in lost revenue, resulting in $2.6 billion in savings, according to Goldman Sachs analysts led by Richard Ramsden.

While the settlement will resolve all of the lender’s disputes with Fannie Mae, Bank of America still faces billions of dollars in claims from investors and federal prosecutors.

Bank of America closed another dark chapter in its history last September, when it agreed to pay $2.43 billion to settle claims it misled investors about the acquisition of troubled brokerage firm Merrill Lynch & Co. Merrill Lynch was initially valued at $50 billion in Bank of America stock in the midst of the 2008 Wall Street meltdown. The "deal of a lifetime” was what Bank of America's then-CEO Kenneth Lewis called it.

The payment is the largest settlement of a shareholder claim by a financial-services firm since the upheaval of 2008 and 2009.

Mortgage Ambitions

Bank of America's $2.5 billion purchase of Countrywide in 2008 briefly made it the top U.S. home lender before the housing market crash saddled the company with more than $40 billion in costs from faulty mortgages and foreclosures.

The lender has since then cut down its mortgage ambitions, accounting for only 4 percent of the nation’s mortgage market -- a slide from just over 20 percent in 2009.

In the first nine months of 2012, Wells Fargo & Company (NYSE: WFC) made 30 percent of all new mortgages, far ahead of the second-place JPMorgan, which accounted for 10 percent of the market, according to the Wall Street Journal, which cited figures from Inside Mortgage Finance. In 2007, Wells Fargo originated 11 percent of new mortgages.

The retreat, however, came at a bad time. Record-low interest rates and federal housing-aid programs spurred a rush of home refinancing, turning the mortgage business into an enormous profit machine. The San Francisco-based Wells Fargo last Friday reported record 2012 net income largely because of a booming mortgage business.

Morgan Stanley analyst Betsy Graseck expects Bank of America’s mortgage banking revenues to come in at 651 million in the fourth quarter, lower than the $2 billion generated in the prior quarter.

The Wall Street Journal reported that Bank of America now plans to resume mortgage marketing and shift some employees who have been working through delinquent loans to processing new mortgages. The bank hired 4,000 loan processors in 2012.

Leaner And Meaner

Bank of America is struggling to show that it can boost earnings amid the stresses of thin margins, slow economic growth and an array of new regulations that are eating into its revenue. Under Chief Executive Brian Moynihan, Bank of America is trying to retool itself into a leaner and more focused company.

Moynihan announced a major cost-cutting plan in 2011 dubbed Project New BAC. Under the program Moynihan said 30,000 jobs would be slashed saving the bank $8 billion by 2015. In the third quarter of 2012, the bank’s full-time head count declined 5 percent, to 272,594 employees.

“We did benefit from lower personnel costs as well as new BAC savings," Thompson said in November of last year at the BancAnalysts Association of Boston Conference. “Those benefits in the (third) quarter, though, were largely offset by the increased expenses … in legacy assets and servicing.”

Bank of America is also shedding non-core assets to raise capital. Since 2010, it has sold more than $50 billion in assets.

As part of its global strategy to move away from international wealth management business and focus resources on markets where it has more competitive strengths, Bank of America in December announced that it is disposing of its Japanese private banking joint venture with Mitsubishi UFJ Financial Group Inc. (TYO:8306) to the Japanese group for about 39 billion yen.

The joint venture -- Mitsubishi UFJ Merrill Lynch PB Securities Co. -- was formed in May 2006 by MUFJ and Merrill Lynch Co. The joint venture was integrated into Bank of American’s operations after it acquired Merrill Lynch during the height of the financial crisis in 2008.

The decision to sell the joint venture in Japan follows Bank of America’s sale of its loss-making, non-U.S. wealth management business to Swiss private bank Julius Baer Group Ltd. in August.

Stock Performance

This is a make-or-break week for the financial sector with five of six of the nation’s largest banks scheduled to report fourth-quarter earnings results.

Wells Fargo was the first mega-bank to report last week, jumping ahead of JPMorgan, which typically starts off bank earnings. Wells Fargo posted profit and revenue above estimates, but raised concerns about net interest margins, or NIM.

JPMorgan and Goldman Sachs Group, Inc. (NYSE: GS) report on Wednesday morning, followed by Citigroup Inc. (NYSE: C) and Bank of America on Thursday, and Morgan Stanley (NYSE: MS) on Friday.

The financial sector as a whole is also projected to see modest revenue growth in the fourth quarter of 2012, the first positive growth in several quarters. The estimated revenue growth rate is 7 percent, according to FactSet.

The Financial Select Sector SPDR (NYSEARCA:XLF), which tracks over 80 diversified financials, is up 4.5 percent since the start of the year and 23.9 percent from one year ago.

Bank of America Corp (NYSE: BAC) doubled its market capitalization last year.

Shares of Bank of America are down 0.1 percent, or 1 cent, at $11.55 apiece in Wednesday’s premarket trading.

“The company is doing a good job freeing up capital and setting in motion real cost saves, but given the recent run up and strong positive sentiment on the stock (and gradual earnings improvement), while we recognize the progress, we see better value in JPM and Citi at these prices,” Nomura analyst Glenn Schorr wrote in a report on Jan. 7.

Schorr assigned a “Neutral” rating to Bank of America and has a target price of $11.25.