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Keeping away from the streak of disappointing results by a few mega banks, Bank of America Corporation (BAC - Analyst Report) came out with a positive earnings surprise of about 11.1% for the third quarter. The banking giant reported earnings per share of 20 cents, beating the Zacks Consensus Estimate of 18 cents. This also compares favorably with the break-even result in the prior-year quarter.

Results for the reported quarter were aided by a substantial reduction in the provision for credit losses and lower noninterest expenses. Though interest and noninterest income showed year-over-year improvement, these were not the major contributing factors this quarter. In fact, excluding debit valuation adjustments (DVA) and fair value option (FVO) adjustments, total revenue (net of interest expense) declined on a year-over-year basis.

As previously announced by the company, results benefited from a $0.8 billion pre-tax gain on the sale of its remaining China Construction Bank shares. However, negative valuation adjustments of $0.4 billion partially offset the benefit. These items had a 2-cent per share positive impact on earnings. Otherwise, BofA would have earned 18 cents per share during the quarter, in line with the Zacks Consensus Estimate.

The quarter witnessed improved credit quality across major portfolios, higher brokerage income and increased equity investment income. However, these positives were partially offset by reduced mortgage banking income and a negative impact from deferred tax assets.

Investment banking performance remained decent, thanks to better capital market activities. BofA maintained its #2 rank in Global Investment Banking fees with a 7.7% market share. Also, it achieved #1 rank in the Americas with 11.0% market share during the quarter. Yet, losses in Consumer Real Estate Services and Global Markets increased over the year-ago quarter.

The company significantly strengthened its balance sheet as reflected by improved capital ratios. Strong time-to-required funding and reduced long-term debt were also among the positives.

Quarter in Detail

Excluding DVA and FVO, fully taxable-equivalent revenues (net of interest expense) were $22.2 billion, down 2% from $22.5 billion in the prior-year quarter. However, this was in line with the Zacks Consensus Estimate.

Net interest income on a fully taxable-equivalent basis was $10.5 billion, up 3% from $10.2 billion in the year-ago quarter. Reduced long-term debt balances, less negative market-related premium amortization, lower rates paid on deposits, and higher commercial loan balances primarily supported this improvement, which was partially offset by a reduction on consumer loan balances as well as lower asset yields. Net interest margin improved to 2.44% from 2.32% in the year-ago quarter.

Noninterest income came in at $11.3 billion, up 7% from $10.5 billion in the prior-year quarter. The reasons for this improvement were lower negative FVO adjustments, higher equity investment income and higher investment and brokerage income. However, lower mortgage banking income partially offset the positives.  

Noninterest expense was $16.4 billion, down 7% from $17.5 billion in the year-ago quarter. Lower litigation expense, lesser expenses in Legacy Assets and Servicing (LAS) and reduction in personnel expense were the main contributors to the reduction.

Book value per share as of Sep 30, 2013 was $20.50 compared with $20.18 as of Jun 30, 2013 and $20.40 as of Sep 30, 2012. Tangible book value per share as of Sep 30, 2013 was $13.62 compared with $13.32 at the end of the prior quarter and $13.48 at the end of the year-ago quarter.

Credit Quality

Supported by the ongoing economic recovery, credit quality continued to improve during the quarter with net charge-offs declining across almost every major portfolio from the prior-year quarter. Provision for credit losses decreased 83% year over year to $296 million.

As of Sep 30, 2013, nonperforming loans, leases and foreclosed properties ratio was 2.17%, down 16 basis points (bps) sequentially and 64 bps year over year. Net charge-off ratio decreased 21 bps sequentially and 113 bps year over year to 0.73%.

Capital Ratios

At the end of the reported quarter, the company’s Tier 1 common capital ratio including Market Risk Final Rule was 11.08% compared with 10.83% at the end of the prior quarter. Tangible common equity ratio was 7.08% compared with 6.98% at the end of the prior quarter and 6.95% at the end of the prior-year quarter.

Competitive Landscape

Among other banking giants that have reported so far, JPMorgan Chase & Co. (JPM - Analyst Report), and Citigroup Inc. (C - Analyst Report) reported disappointing third quarter results. Massive legal expense dampened JPMorgan’s results, while Citigroup suffered from credit and debt valuation adjustments.

However, Wells Fargo & Company (WFC - Analyst Report) has maintained its track record of beating the Zacks Consensus Estimate with the help of disciplined expense management and improved loans and deposits.   

Our Viewpoint

BofA continues to show strength in its balance sheet and liquidity, which is reflected through improved capital ratios. Nevertheless, we expect continuous litigation and various regulatory issues to impact its results in the near to medium term.

Overall, the company has recovered significantly over the last few quarters, as evident from its earnings streak. In addition to realigning its balance sheet in accordance with regulatory changes, the company has taken measures to contain cost. These efforts vouch for better prospects going forward.

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