Earnings Preview: Bank of America Seen With Modest Loss on Legal Charges, Headwinds

When troubled Bank of America Corp. (NYSE: BAC) reports its third-quarter earnings Wednesday morning, most Wall Street analysts expect it will reveal a substantial drop in both revenue and income from a year ago. Such result would be in sharp contrast to the numbers presented by BofA's three major U.S. competitors in recent days, which have exceeded stock pickers’ expectations.

According to Reuters, analysts who follow Bank of America’s business see the Charlotte, N.C.-based company -- still haunted by mistakes made in the run-up to and during the global financial crisis of 2008 -- reporting a net loss of $94.58 million, or 7 cents a share, on revenues of $21.89 billion. That would compare to year-ago profits of $5.89 billion, or 56 cents a share, and it would be a drop of 23.1 percent on revenues from the same quarter in 2011.

Those analysts have grown increasingly dim on Bank of America’s earnings potential, particularly after a late September announcement that it would take a $1.9 billion hit in the quarter on an investor lawsuit settlement. Specifically, the bank was tabling charges stemming from its decision to buy brokerage Merrill Lynch four years ago. Before that news broke, analysts saw the bank as potentially reporting earnings of 13 cents per share during the quarter.

But that legal write-off is not the only headwind analysts expect to hit Bank of America’s bottom line. Analysts at Morgan Stanley, for example, cut their earnings estimate for Bank of America earlier this month on the view that the continued low interest rate environment would compress the margins the institution could see on its loan book. Other banks have faced the same issue, but have more than made up for lower earnings potential through higher volume.

There are also other litigation matters, particularly related to the mortgage-underwriting practices of acquisition Countrywide Financial Services, that, according to experts at credit rating firm Fitch, "will continue to weigh on BAC's overall earnings profile" in the near future.

Marketwatchers also will be careful to observe not just how much Bank of America reports on its bottom line, but exactly how it gets there. Quarterly reports by Wells Fargo and Company (NYSE: WFC), Citigroup Inc. (NYSE: C) and JPMorgan Chase and Co. (NYSE: JPM) have all been boosted by an accounting maneuver where they have poached from reserve funds previously set aside to cover bad loans. While such moves have been dubious at every institution, they would be particularly unwelcome to investors in Bank of America, which is seen as having a weaker balance sheet cushion.

In the past four quarters, funds released from that reserve have accounted for 46 percent of Bank of America’s profit, according to an analysis by the Wall Street Journal.

Of course, there is a possibility that Bank of America will outperform market expectations Wednesday, especially given how low they are currently.

In an interview with Japanese newspaper Nikkei earlier this month, chief executive Brian Moynihan said he saw the U.S. housing market as engaged in a "real" turnaround, something that could foreshadow some unexpected strength in the mortgage origination department.

The market itself has been more than a bit optimistic on the bank, with the stock closing Monday at $9.44 per share, a few percentage points shy of its 2012 highs and 69.8 percent higher than at the beginning of the year.