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Bank of America Corporation (BAC - Analyst Report) reported break-even earnings per share for the third quarter, substantially better than the Zacks Consensus Estimate of a loss of 7 cents. However, this compares unfavorably with the earnings of 56 cents in the prior-year quarter.

Results for the reported quarter were aided by a substantial slowdown in provision for credit losses and almost stable noninterest expense. The quarter witnessed improvement in credit quality across most major portfolios. Also, strong mortgage banking and investment banking performances were among the high points of the quarter. On the flip side were lower net interest income and noninterest income.

As previously announced by the company, results for the quarter were negatively impacted by certain special items – debit valuation adjustments (DVA) and fair value option (FVO) of $1.9 billion, litigation expense of $1.6 billion and a charge related to a reduction in the U.K. corporate tax rate $0.8 billion. These three items had a $0.28 per share negative impact on earnings. Otherwise, Bank of America would have earned 28 cents per share during the quarter.   

The company made significant progress in strengthening its balance sheet during the quarter, reflected by improved capital ratios. Strong time-to-required funding and reduced long-term debt were also among the positives.
 
Quarter in Detail

Fully taxable-equivalent revenue (net of interest expense) was $20.7 billion, down 28% from $28.7 billion in the prior-year quarter. Revenue also missed the Zacks Consensus Estimate of $21.6 billion.

Net interest income on a fully taxable-equivalent basis was $10.2 billion, down 5% from $10.7 billion in the year-ago quarter. Reductions in consumer loan balances were largely responsible for the downfall, which was partially offset by a reduction in long-term debt balance and lower rates paid on deposits. Net interest yield remained flat compared with the year-ago quarter at 2.32%.

Noninterest income came in at $10.5 billion, down 42% from $18.0 billion in the prior-year quarter, primarily due to negative DVA and FVO adjustments and lower equity investment income.  

Non-interest expense was $17.5 billion, almost flat compared with $17.6 billion in the year-ago quarter. An increase in other general operating expense related to Merrill Lynch class action settlement was offset by a decrease in personnel expense.

Book value per share as of September 30, 2012 was $20.40, compared with $20.16 as of June 30, 2012 and $20.80 as of September 30, 2011. Tangible book value per share as of September 30, 2012 was $13.48, compared with $13.22 at the end of the prior quarter as well as the prior-year quarter.

Credit Quality

With the gradual recovery of the economy, credit quality continued to improve during the quarter with net charge-offs declining across almost all major portfolios from the prior-year quarter. Provision for credit losses decreased 48% year over year to $1.8 billion.

As of September 30, 2012, nonperforming loans, leases and foreclosed properties ratio was 2.77%, down 38 basis points (bps) from the prior-year period. Net charge-off ratio decreased 31 bps year over year to 1.86%.

Capital Ratios

At the end of the reported quarter, the company’s Tier 1 common capital ratio (Basel 1) was 11.41% compared with 11.24% at the end of the prior quarter and 8.65% at the end of the prior-year quarter. Tangible common equity ratio was 6.95% compared with 6.83% at the end of the prior quarter and 6.25% at the end of the prior-year quarter. As of September 30, 2012, the Tier 1 common capital ratio under Basel 3 was estimated at 8.97%, up from 7.95% as of June 30, 2012.

Competitive Landscape

BofA’s competitors –– JPMorgan Chase & Co. (JPM - Analyst Report) and Wells Fargo & Company (WFC - Analyst Report) –– upheld the banking image with strong third quarter results primarily on the back of improvement in capital market activity and healthy mortgage business. For JPMorgan, results primarily benefited from improved revenue, while Wells Fargo primarily benefited from lower expenses.

Citigroup Inc. (C - Analyst Report) and The Goldman Sachs Group Inc. (GS - Analyst Report) also reported better-than-expected third quarter earnings. While Goldman’s results were aided primarily by a substantial growth in revenue, Citigroup benefited from reduction in loan loss provisions.

Our Viewpoint

Through the sale of its non-core assets, BofA has been striving hard to improve its capital levels. This effort has resulted in success with respect to clearing the most difficult stress test (fourth round) conducted by the Fed.

Nevertheless, we believe that various revenue headwinds, elevated operating expenses and issues related to regulatory changes will continue to impact near-term results.

Overall, the company is making every effort to keep itself afloat. Measures like realigning the balance sheet in accordance with regulatory changes, launching expense reduction initiatives and continuously improving asset quality vouch for better prospects.

BofA currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Also, we maintain a long-term ‘Neutral’ recommendation on the shares.

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