Why Bank of America's Investors Can Breathe a Sigh of Relief

If you're an investor in Bank of America (NYSE: BAC  ) , the Federal Reserve's most recent round of stress tests should serve as a partial affirmation of your patience in the company. Released yesterday, the nation's second largest bank by assets emerged from the central bank's gauntlet in markedly better shape than it did last year. The charts and discussion below examine how the company's capital and earnings held up under the Fed's "severely adverse" economic scenario.

The purpose of the stress tests is to gauge how the capital bases of the nation's largest financial institutions hold up in the face of economic and financial turmoil. Among other things, the most extreme case assumes that real GDP declines an average of 4% this year, unemployment ratchets up to 12.1% by the second quarter of next year, and home prices plummet by 20% over the next 24 months.

As you can see in the chart below, B of A's Tier 1 common capital ratio held up admirably in light of these assumptions. Starting from 11.4% at the end of last September, it bottomed out at 6.8% over the hypothetical time period extending from the fourth quarter of last year through the end of 2014. While that equates to a 40% decline, the ending figure nevertheless comfortably exceeded the Fed's 5% reference rate. By comparison, the average Tier 1 common capital ratio of the 18 institutions tested fell by a third, down to 7.4%.

Source: Federal Reserve.

With respect to net income, B of A didn't fare as well. Its hypothetical pre-tax loss for the nine-quarter time period came in at $51.8 billion. This greatly exceeded the 18-institution average loss of $10.8 billion, and made B of A the worst performer in this regard. Conversely, the Bank of New York Mellon fared the best, with $5.5 billion in earnings despite the assumed economic Armageddon.

Source: Federal Reserve.

Breaking this down a bit further, as you can see in the figure above, B of A's $24.1 billion in pre-provision net revenue was more than consumed by loan loss provisions -- that is, money set aside to cover future losses from soured loans. These accounted for $49.7 billion in losses. In addition, estimated losses from trading added up to $14.1 billion, and "other losses" ate up an additional $13 billion.

And digging into the loan losses specifically, B of A's were widely dispersed among customer and product types. A full 43% derived from residential real estate, 27% from its credit card operations, and a total of 23% from various types of commercial lending.

Source: Federal Reserve.

At the end of the day, the stress tests are meant to do exactly what the name implies: stress you out. And while this year is no exception, investors in B of A should take comfort in the increasingly massive capital hoard sitting on the bank's balance sheet.

Want to learn more about B of A?
Bank of America's stock doubled in 2012. Is there more yet to come? With significant challenges still ahead, it's critical to have a solid understanding of this megabank before adding it to your portfolio. In The Motley Fool's premium research report on B of A, analysts Anand Chokkavelu, CFA, and Matt Koppenheffer, Financials bureau chief, lift the veil on the bank's operations, including detailing three reasons to buy and three reasons to sell. Click here now to claim your copy.


Read/Post Comments (0) | Recommend This Article (1)

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.

Be the first one to comment on this article.

DocumentId: 2498781, ~/Articles/ArticleHandler.aspx, 7/30/2014 10:00:50 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement