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The Truth Behind Bank of America's Earnings

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Bank of America (NYSE: BAC  ) released earnings this morning that, at first glance, look too good to be true. To be frank, they are. I'll explain.

Net income in the first quarter came in at $4.2 billion, or $0.44 per share after preferred dividends, mainly to the U.S. government. That was nearly double what the bank earned in the same period last year, and well ahead of analyst expectations of $0.04 per share.

Good news, right? Yet shares are crumbling nearly 18% as I write. What gives?

Just like Citigroup (NYSE: C  ) last week, B of A's earnings are made up almost entirely of either one-time items, or items no sane investor would consider actual income. Particularly:

  • A $2.2 billion mark-to-market gain due to Merrill Lynch's credit spreads blowing out. Yes, this is indeed a sign that the company could be heading for big trouble, but accounting rules allow companies to book widening spreads as income, since they could theoretically buy back debt at a discount.
  • A $1.9 billion pre-tax gain on the sale of shares of China Construction Bank.

Add the two up, and there's your net income in its entirety. In other words, looking at earnings on any normalized -- or rational -- basis, B of A barely broke even. That isn't too surprising when you look at how quickly credit quality fell off a cliff:

  • Provisions for credit losses more than doubled to $13.4 billion.
  • Net charge-offs surged to 2.85%, from 1.25% a year ago.
  • Nonperforming assets exploded to 2.65%, up from 0.90% a year ago.
  • Credit card losses as a percentage of receivables jumped to 8.62%, from 5.19% a year ago.  

A fallout in credit quality -- particularly on the consumer side -- is to be expected. Problem is, B of A is knee-deep in all the wrong places right now, and doesn't have the balance sheet strength to pull off this kind of deterioration without raising capital. That'll likely have to come from converting government-issued preferred shares into common equity, diluting the pants off of existing investors.

In an environment where borrowing costs are zero and stronger competitors like Wells Fargo (NYSE: WFC  ) , Goldman Sachs (NYSE: GS  ) , and JPMorgan Chase (NYSE: JPM  ) are accordingly spewing profits, B of A isn't keeping up with the pack. And in an industry where only the strong survive, that isn't a happy spot to be sitting in.

Got your own take on B of A? Feel free to share it in the comment section below.

Related Foolishness:

Fool contributor Morgan Housel doesn't own shares of any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (7) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 20, 2009, at 1:59 PM, riotercero wrote:

    the banks are insovents got that right

  • Report this Comment On April 20, 2009, at 4:49 PM, multi007 wrote:

    I got several thousand shares at $4.89 and $5.33 and I love BAC. They are not insolvent. They are not going bankrupt. They are not going to need more TARP. Even the author of this article see's this.

    But to answer the author's question "Good news, right? Yet shares are crumbling nearly 18% as I write. What gives?" Well the answer is simple. FEAR. Fear is what is leading this market. People are running away which causes the stock to drop, and fear is causing the people to run back into the market (hence the 30% run we recently had) - people were afraid they would miss the next big jump in the market. BAC is just fine. I'll be buying more tomorrow. If it drops more in the next hour, I'll buy mroe in afterhours trading.

  • Report this Comment On April 20, 2009, at 8:04 PM, baggins2000 wrote:

    The reason I'm moving out of BoA is that the last time I did a check on my credit card they asked me no less than 3 times whether I would pay my bill.

    I guess it was mainly because they had hiked the rates on credit cards again.

    Yes, I'm going to pay my bills, but I'm transferring all of my accounts to Wells Fargo. Started working on it today. Adios BoA.

  • Report this Comment On April 20, 2009, at 9:20 PM, MaxDiesel wrote:

    Speculated, road it, and jumped off just before they showed there true colors. Thanks B of A!

  • Report this Comment On April 21, 2009, at 9:46 AM, spindor wrote:

    BofA is the most unfriendly of the banks. I canceled my credit card (bal < $300) after they tripled my interest rate for using less than 10% of my HELOC. Get this, the HELCO was at another bank(!!). I only used it to repave my driveway, which was in ugly shape.

    Bye bye, BofA!

    Good riddance to bad rubbish and lousy banking.

    No More BofA!

    Ken Lewis should take a couple years off! Wish their Board had some common sense and dumped him.

  • Report this Comment On April 22, 2009, at 5:13 PM, mythicalmike4 wrote:

    Morgan Housel does a lot of BAC bashing for some reason. I see little difference in what they reported in 1Q compared to JPM and WFC. Looking at each Banks 1Q financial statements you see they all benefited from credit spreads. The removal of the 1.9M pre-tax gain from China Construction bank would only put them in line with other Banks since BAC had income $1.2B greater than its nearest peer for the quarter. Two other points: charge-offs only increased $1.4B so the negative inference on the "provisions for credit losses more than doubled" statements are a little mis-leading. BAC increased it's reserves by almost $5B. Secondly - $36 Billion in Revenue is HUGE no matter how you slice it. It shows cash flow power of this franchise will help it through this economy considering no other Bank has revenue of even $29 Billion.

  • Report this Comment On February 26, 2011, at 5:13 PM, ronrh wrote:

    well i got news for all of you the BIG BANKS don't give a rat's asssssss about their customers unless you have multiple accounts with millions involved. see if any decisions are made locally about anything pertaining to local customers,fat chance. decisions that are made are by people who are NOT INVOLVED WITH YOUR SITUATION. ALL THEY WANT TO DO IS JUGGLE MONIES BETWEEN FINANCIAL INSTITUTIONS AND FOREIGN ENTITIES

    i say join your local credit union and just maybe some sense of your situation and local conditions will be allowed to be factored in to a decision that will allow your needs to be meet

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