(BAC) Bank of America’s Second Quarter 2010 Earnings Beat on Lower Credit Costs

July 17th, 2010 | by Maddison Paltridge |

Bank of America Corporation’s (BAC) second quarter 2010 earnings came in at 27 cents per share, 3 cents ahead of the Zacks Consensus Estimate of 24 cents. However, this compares unfavorably with the earnings of 33 cents in the prior-year quarter.

Lower credit costs and sale of non-core assets were primarily responsible for the better-than-expected results. However, pressure on trading and mortgage banking income was the primary offsetting factor. BofA’s trading business includes the Merrill Lynch operation. An increased charge related to the U.K. payroll tax was also among the negatives.

Net income came in at $3.1 billion, down 3% from $3.2 billion in the year-ago quarter. However, after preferred dividends, net income increased 15% year over year to $2.8 billion.

Behind the Headlines

Fully taxable-equivalent revenues net of interest expense were $29.5 billion, down 11% from $33.1 billion in the prior-year quarter, reflecting the absence of year-earlier gains from the sale of BofA’s shares in China Construction Bank and the contribution of a merchant services business.

Net interest income on a fully taxable-equivalent basis was $13.2 billion, up 11% from $11.9 billion in the year-ago quarter. The increase was primarily due to the addition of net assets of approximately $100 billion to the balance sheet as a result of the adoption of the new consolidation guidance, effective January 1, 2010.

As a result of the accumulation of higher-yielding loans on the balance sheet, net interest yield increased 13 basis points (bps) year-over-year to 2.77%.

Non-interest income came in at $16.3 billion, down 23% from $21.1 billion in the prior-year quarter. The decline was driven by reduced trading account profits, equity investment income, mortgage banking income and net gains on sale of debt securities.

Non-interest expense was $17.3 billion, up 1% from $17.0 billion in the prior-year quarter. The increase in non-interest income reflects higher personnel costs due in part to the U.K. payroll tax and increased professional fees. Pretax merger and restructuring charges declined to $508 million from $829 million in the year-ago quarter.

The efficiency ratio on a fully taxable-equivalent basis was 58.58% compared to 51.44% in the prior-year quarter.

Book value per share as of June 30, 2010 was $21.45, compared to $21.12 as of March 31, 2010 and $22.71 as of June 30, 2009.

Evaluation of Credit Quality

Overall credit costs declined for the fourth consecutive quarter. However, credit quality was mixed during the quarter. Provisions for credit losses decreased 17% sequentially and 39% year over year to $8.1 billion.

Non-performing loans, leases and foreclosed properties decreased 1% sequentially but increased 15% year-over-year to $35.7 billion. Net charge-offs decreased 11% sequentially but increased 10% year-over-year to $10.0 billion. Net charge-off ratio improved 46 bps sequentially to 3.98% but nonperforming loans ratio deteriorated 5 bps sequentially to 3.74%.

Capital Ratios

At the end of the reported quarter, the company’s Tier 1 capital ratio improved to 10.67% from 10.23% at the end of prior quarter. Tier 1 common ratio also improved to 8.01% from 7.60% at the end of the prior quarter.

The market turmoil was more harmful to BofA than its peers, besides Citigroup (C). However, BofA has concluded its biggest acquisitions. The company acquired Merrill Lynch at about the height of the financial crisis last year. It also acquired Countrywide Financial Corporation in July 2008. This will allow the bank to focus on rebuilding customer relationships.

After incurring significant losses for the last two quarters of 2009, backed by strong activity primarily in the capital markets, the company has bounced back to profitability during the first quarter of 2010. We are also impressed to see better-than-expected second quarter results in a sluggish economic recovery.

However, there are concerns related to the impact of the upcoming financial reform bill. Following congressional approval, the financial reform bill would partially restrict proprietary trading of commercial banks. Also, derivatives trading would be restricted, which are used to hedge risk or speculate the future value of assets. As a result, a significant impact on profitability is expected for the big commercial banks including BofA, JPMorgan Chase & Co. (JPM), Wells Fargo (WFC), Goldman Sachs (GS), Morgan Stanley (MS) and Citigroup.

Though continuing pressure on trading revenues will hurt the profitability of BofA in the upcoming quarters, a slowdown in loan loss reserves as exist at other large banks will support the bottom-line.

Most of the major banks are still suffering from losses related to mortgages and credit cards of their retail banking operations. However, on Thursday, JPMorgan — the first of the major banks to report — posted strong second quarter results, primarily supported by a slowdown in loan loss reserves. JPMorgan’s second quarter earnings came in at $1.09 per share, substantially ahead of the Zacks Consensus Estimate of 71 cents. Obviously, the results of JPMorgan and BofA have raised the bar for other major U.S. banks.

Since the announcement of results, the share price of BofA has decreased 6.2%.

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