- Bank of America missed on revenue and was in-line on earnings.
- However, expectations were weak going into the quarter, so the mixed results were well received by the investor base.
- I anticipate upside to valuation due to net interest margin expansion and less severe net charge-offs.
Bank of America (NYSE:BAC) more or less had an in-line quarter on earnings and missed on sales. The miss on sales was mostly attributable to net interest income adjustments due to bond premium amortizations. The core net interest income was strong with the net interest margin (NIM) expanding modestly on the core loan portfolio (roughly 5 basis points to 2.31% NIM). The balance sheet metrics showed some modest improvement due to common tier 1 equity (CET 1) increasing from $175.814 billion to $181.393 billion thus translating to a CET 1 ratio of 10.1% from 9.8%, which sufficiently addresses the fully phased in requirements prior to the 2019 deadline.
Therefore, Bank of America is better positioned to return capital as a portion of all HQLA (high quality liquid assets), which implies higher capital return/payout ratios in FY’17.
Earnings commentary followed by analyst revisions
Going into the quarter many analysts were worried about broader sector trends pertaining to mortgage originations, trading, investment bank fees and loan loss reserves. Thankfully things weren’t as bad as they could have been, as energy prices continue to recover, which implies that the current loan loss reserve could prove too aggressive. This may translate into a lower net charge-off rate down the road. I anticipate that loan loss reserves or provisions for credit losses won’t be fully utilized in the current fiscal year, which may be indicative of healthier EBT metrics down the road. Furthermore, Bank of America’s results
I anticipate that loan loss reserves or provisions for credit losses won’t be fully utilized in the current fiscal year, which may be indicative of healthier EBT metrics down the road. Furthermore, Bank of America’s results were impacted by accounting adjustments (FAS 91 and FAS 123), which reduced EPS by $0.12 in the quarter, which compared to $0.08 (negative impact) in the prior year period.
Bank of America reported revenue of $19.573 billion and $0.21 EPS, which compared to consensus estimates of $20.3 billion and $0.21.
Key commentary from analysts coming out of the quarter was broadly upbeat but some analysts have revised EPS estimates slightly lower. Given Bank of America doesn’t provide exact financial guidance the consensus range tends to be wider, which tends to increase volatility following an earnings report.
Key earnings commentary coming out of the report from Barclays PLC, Oppenheimer Co., RBC Capital Markets, UBS AG and Deutsche Bank AG:
While no formal dollar targets were laid out, it did say it “needs” to drive its efficiency ratio to the low 60%’s (67% in 1Q ex. FAS 91/123R). Nevertheless, even ex. FAS 91/123R, its ROTCE was a relatively low 8.4%, implying to us cost controls will need to be met with improved revenues in order to return to double-digits. We are lowering our 2016 EPS estimate by $0.05 to $1.35. Our 2017 EPS estimate remains $1.65. Barclays reiterated its Equal Weight rating and $19 price target. – Jason M. Goldberg, Barclays PLC
The stock remains down 16% YTD (vs up 1.9% for the S&P 500) on overblown credit fears, and we would expect this deficit to be recouped as credit quality will likely remain very strong. We made only minor tweaks to our earnings model, mainly incorporating some guidance around FDIC assessments and a UK tax charge in 3Q16. Oppenheimer lowered EPS from $1.44 to $1.38 and raised price target from $19 to $20. – Chris Kotowski, Oppenheimer Co.
Overall Bank of America still released $71M of reserves (vs. $334M in 4Q15) due to further improvement in the consumer portfolios, and the total allowance remained healthy at 1.41%/loans. After adjusting for 1Q16 results, we are maintaining our EPS estimate for 2016 at $1.35 but trimming 2017 to $1.60 from $1.65. We reiterate our Outperform rating and $18 target. – Joe Morford, RBC Capital Markets
BAC's energy reserve stands at just over $1 billion, and while these reserves cover the full energy portfolio, they would represent 13% of the $7.7 billion in E&P and oil field services exposures. Importantly, this $7.7 billion represents less than 1% of total loans although 56% of this utilized exposure is criticized. We are lowering our 2016 EPS estimate to $1.25 from $1.30. Our 2017 EPS estimate is unchanged at $1.60 (UBS reiterated its $18 price target). – Brennan Hawken, UBS AG
While BAC benefited from the rise in short rates (core net II rose $100m, core NIM +5bps), reported net interest income was lower (as expected) due to lower long term rates. Loans were flattish vs. 12/31 and +3% yoy. Deutsche Bank reiterated its $1.25 EPS estimate and $17 price targets. – Matt O-Connor, Deutsche Bank AG
Concluding thoughts on the quarter
The recent reduction to sell side estimates creates a better environment for Bank of America to deliver earnings/sales beats over the course of FY'16. Furthermore, the weakness in revenue was primarily due to one-off issues. Assuming the core banking franchise continues to grow and back half investment banking activities improve, the company will deliver above consensus results.
Furthermore, a recent global asset manager survey done by Bank of America Merrill Lynch implies flat assets under management growth for the duration of the year. However, given the recent momentum in U.S. equities I could see performance fees improving, so asset management could be a back-half story for Bank of America's global wealth and investment management (GWIM) segment.
I believe loan loss reserve build could prove too aggressive implying better EBT margins down the road. While accounting adjustments remain a major headwind, the core growth in lending along with reduced exposure to mortgage servicing rights (MSRs) implies better operational synergies down the road. Furthermore, I believe interest rates could move higher driving incremental upside to revenue.
A 100 basis point improvement to the interest yield curve roughly translates into $6 billion incremental benefit to net interest income, which is enough to drive a 16.3% improvement in net interest income in FY’16. Granted, I anticipate a 50 basis point improvement in yields across the curve, which limits revenue upside to 8% or $3 billion.
I have yet to model out estimates for the current fiscal year. However, Bank of America remains undervalued given weak investor sentiment. Analyst models will revolve around loan loss reserves and net interest margins. If both of these metrics see improvement I could see the stock outperforming its bank peers with the exception of JPMorgan Chase.
While investors should be more scrutinizing following a lumpy quarter for banks, Bank of America's portfolio seems less risky when compared to some of the other banks. As such, I reiterate my buy recommendation.