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There are some stocks people watch closely, and there are others investors tend to ignore. Bank of America (BAC 0.87%) falls squarely into the first camp, which was a good thing for its shareholders this week, as the bank's stock rose more than 4% in the wake of its second-quarter earnings report on Monday.
To be clear, the North Carolina-based bank didn't have a spectacular quarter. It earned $0.42 per share on an adjusted basis, which translated into a 0.91% return on average assets and a 10.9% return on tangible common equity. Both figures are below the bank's targets of 1% and 12%, respectively. They also suggest the bank isn't earning its cost of capital, which falls around these same thresholds.
The problem is that Bank of America isn't generating enough revenue. Even after adjusting for the idiosyncratic way it accounts for the impact on its net interest income from interest rate fluctuations, which reduced its net revenue by $1.2 billion last quarter, the bank still produced less revenue than smaller rival Wells Fargo (WFC 0.51%).
*Adjusted for non-cash accounting charges. Data source: Bank of America and Wells Fargo. Chart by author.
Higher interest rates will help Bank of America in this regard, as its top line is more sensitive to interest rate changes than those of many of its rivals. Bank of America projects that a 100 basis point increase in short- and long-term rates would boost its net interest income by $7.5 billion over the course of a year.
Bank of America's bottom line should also get some help over the next three years thanks to a new cost-cutting initiative announced by chairman and CEO Brian Moynihan on the company's quarterly conference call. The bank's goal, says Moynihan, is to reduce annual operating expenses $3 billion by 2018. That's on top of $15 billion worth of annual cost cuts since 2011.
Beyond the latest cost-cutting initiative, it seems the reason Bank of America's shares responded so positively to its second-quarter earnings was because it didn't fare as poorly through the especially eventful three-month stretch as analysts and commentators thought it would. Most notably, its trading results held up well despite the uncertainty surrounding the June 23 vote in the United Kingdom to separate from the European Union. Compared to the same period last year, its sales and trading revenue rose 14%.
It also recorded lower energy-related losses even though the price of oil remains depressed. Its adjusted net interest margin improved, too, benefiting from the Federal Reserve's decision in December to increase short-term rates by a quarter of a percent. And if you exclude the aforementioned accounting adjustments, both its revenue and earnings per share rose on a year-over-year basis.
It's also worth noting that Bank of America passed the stress test in the second quarter, announcing immediately thereafter a 50% dividend hike as well as a $5 billion share buyback plan. And one week later, the bank said it would shutter its legacy assets and servicing unit, which was created five years ago to house the bank's toxic and noncore assets.
In short, while Bank of America still has a way to go before it returns to the upper echelon of its industry, there's no question its performance in the second quarter represents a step in the right direction.
