Bank of America (NYSE:BAC) reached a number of important milestones in 2005, but two stood out as especially promising developments. First, the FleetBoston Financial acquisition was smoothly integrated, and B of A now boasts a nationwide branch network, including dominant positions in some of the largest and fastest-growing geographic markets. Second, the acquisition of MBNA was announced, which would push B of A ahead of both JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C) as the nation's largest issuer of credit cards.

In light of such progress, why would the bank deliver what many analysts considered to be mediocre financial results?

The past year turned out to be a tough operating environment for banks, and there were direct consequences for B of A's bottom line. One factor that weighed heavily on banks' earnings was increased credit costs. Higher charge-offs and provisioning costs shaved billions off B of A's pre-tax income. Much of the higher costs, however, were non-recurring expenses resulting from the nature and timing of new bankruptcy legislation.

The other factor that challenged profitability was the flat yield curve, which often seems like a benign phenomenon when discussed in the abstract. But the narrow spread between short- and long-term interest rates had a noticeable impact on B of A's bottom line. The bank was able to increase net interest income to $30.7 billion in 2005, largely as a result of the FleetBoston acquisition. The net interest margin, however, shrank 33 basis points to 2.84% at the end of 2005 as a result of the compression of the yield curve -- with an estimated cost as high as several hundred million dollars of earnings.

The current year offers considerable hope that B of A will increase the $16.5 billion in net income it posted in 2005. The negative impact of new bankruptcy legislation is now past, and the yield curve has been steepening in recent weeks. Bank of America is well-positioned to leverage its leading 10% market share in low-cost deposit accounts to create significant growth in net interest income. At a recent share price of $46, or less than 12 times earnings, B of A seems like a very good buy for such a powerful financial juggernaut.

B of A's next test will come on April 20, when the bank releases its first-quarter results. B of A investors, who calibrated their earnings expectations against Citigroup's recently released first-quarter results, might end up disappointed. Investment banking is largely responsible for the 4% increase in Citigroup's net income, but B of A's investment banking arm is a smaller unit, unlikely to deliver similar results. Perhaps a better way to judge B of A's performance is to look for strong loan growth on its balance sheet. Increased lending activity would validate the company's expansion strategy and portend more robust earnings growth when the interest rate environment improves.

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