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.

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