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Traders and investors are pounding Bank of America (NYSE: BAC ) today after it reported earnings for the fourth quarter and 12 months ended Dec. 31. While most mainstream media appears to be taking a cue from the performance of B of A's stock following the announcement, the reality is that the bank had an otherwise positive quarter and fiscal year. In addition, it's now positioned to drive core earnings going forward and distribute a portion of those to shareholders.
Understanding the Bank of America earnings report
To get a feel for how B of A performed last quarter, it's first necessary to cut through some of the noise in its earnings -- by this I mean nonrecurring items that have little bearing on the bank's core operations. Once offsetting benefits and expenses are excluded, the bank's fourth-quarter earnings come in just south of $5 billion. On an annualized basis, that equates to nearly $20 billion, or $2 per share -- not bad when you consider B of A's shares currently cost between $11 and $12 a piece.
What are these one-time expenses you ask? Most have to do with two settlements B of A entered into at the beginning of last week -- which, due to accounting rules, were includable in last quarter's earnings. The largest charge-off, $2.7 billion to be precise, settled essentially all past and future repurchase claims by Fannie Mae related to toxic mortgages originated by Countrywide Financial, which B of A acquired in 2008. The bank also recorded a $1.1 billion loss to eliminate foreclosure-related claims brought by the Federal Reserve and the Office of the Comptroller of the Currency, the banking industry's two primary regulators in addition to the FDIC.
The good news is that there's an end to these types of charges. The bad news is that B of A isn't there yet. Its biggest remaining liabilities now concern claims by private investors and insurance companies that were similarly stiffed by Countrywide before B of A acquired it. However, at least a significant portion of these are already reserved for. According to B of A, its exposure for claims like these going forward is capped at around $4 billion beyond allocated provisions, or approximately one fiscal quarter's worth of earnings. In other words, it at least appears as if the end of B of A's Countrywide nightmare may be in sight.
Now that we've excluded the noise, it's possible to get a truer feeling for how B of A performed last quarter. And in this regard, I want to point out three important takeaways. First, it's becoming increasingly clear that the acquisition of Merrill Lynch in September of 2008 will ultimately pay off for B of A and its shareholders. According to B of A's press release, its investment bank maintained the No. 2 ranking in global and domestic investment banking fees, which were up 20% sequentially and 58% on a year-over-year basis.
Second, B of A continues to make progress on its goal to decrease annual expenses by $8 billion by 2015. For the 2012 fiscal year, total noninterest expenses declined by $8.2 billion -- though the figure drops to roughly $4.4 billion once certain impairment and restructuring charges occurring in 2011 are excluded from the analysis. Under the auspices of Project New BAC, the bank reduced its headcount over the year by approximately 14,000 people and decreased by its branch and ATM counts by roughly 200 and 1,500 units, respectively.
Finally, both its capital ratios and book value continued their impressive upward momentum. In terms of the all-important former, B of A estimates its Basel III Tier 1 Common Capital Ratio at 9.25%, up from 8.97% at the end of the third quarter. While all of this improvement came in the form of a reduction in risk-weighted assets, which went from $1.5 trillion in the third quarter down to $1.39 trillion at the end of the year, the fact remains that B of A remains the best capitalized of the too-big-to-fail lenders. According to my calculations, in fact, assuming its SIFI buffer is only 1%, as has been intimated, B of A now has roughly $17 billion in excess core capital, above and beyond its requisite 8%.
What does this mean? To me, it means that B of A is well-positioned to receive approval from regulators to increase its dividend and/or institute a share buyback program. In addition, with respect to its book value, B of A now estimates its tangible book value at $13.36 per share, up from $12.95 per share at the end of the third quarter. And again, its shares currently trade for less than $12 per share.
So what does all this mean?
I remain exceptionally optimistic about B of A going forward. Make no mistake about it, the bank has many issues, many of which will be expensive to resolve. Among other things, its nonperforming loans ratio remains more than twice where it should be, and its mortgage underwriting operations are comparatively limping along. But the importance of its settlement with Fannie Mae and the banking regulators simply can't be overstated. Not to mention the fact that its core operations now appear to earn enough to offset its legacy issues, and it has sufficient capital to absorb any excess.
Yet, due to lingering concerns, B of A's shares continue to trade for a healthy discount to tangible book value. Take JPMorgan Chase (NYSE: JPM ) and Wells Fargo (NYSE: WFC ) as two comparisons. Both of these banks reported record earnings for the fourth quarter and 12 months ended Dec. 31. JPMorgan earned an astounding $21 billion for the year despite writing off $6 billion related to the London Whale debacle. And Wells Fargo reported a similarly impressive $18 billion in net income on the back of massive mortgage underwriting activity related to refinancing throughout the year.
It's for these reasons, in turn, that both of these lenders trade for substantial premiums to their respective tangible book values, leaving much less room for share-price appreciation. And herein lies the opportunity for B of A. If it's able to rejoin the pack, the upside potential for its shares, to say nothing of its dividend, is massive. You just have to be patient and comfortable with the risk.