In this video, Motley Fool banking analyst David Hanson breaks down the second-quarter earnings from Bank of America (NYSE:BAC) and highlights a few things to love, as well as a few things that concern him.
A full transcript follows.
Hey, Fools. David Hanson here. This morning, we saw Bank of America report second-quarter earnings. They're the last of the Big Four U.S. banks to report earnings this season, and it was a little bit of a mixed bag. We saw the bank report net income of roughly $4 billion, which seemed strong; however, if we look at it at a tangible book value per share basis -- that actually fell from first quarter, despite the bank raking in over $4 billion in net income plus doing $1 billion of share buybacks.
So, what does this mean? Why do we care that tangible book value per share fell? The reason tangible book value per share fell in the second quarter was this rise in interest rates. When interest rates rose, the bank made a little bit more money on the income that they're making off interest, on the securities that they're holding, but the value of the fixed-income securities that they hold on their balance sheet, those fell, so when interest rates rise, fixed-income securities fall in price.
Now, these aren't actually realized losses that affect net income, but the bank has to record and recognize these unrealized losses that totaled over $4 billion. So we had over $4 billion in unrealized losses and then around $4 billion in net income, so it essentially wiped that out completely to the common shareholder on a tangible book value basis.
So, that doesn't sound very good -- so why is the stock up this morning? There were certainly some things like in Bank of America's second quarter from a business perspective, not necessarily these accounting gimmicks -- not necessarily gimmicks, but these accounting entries that offset in different places.
Just when we look at Bank of America's business, there are certainly some things to like. The wealth-management business, the Merrill Lynch unit that they of course acquired in late 2008 at a very high price, is actually starting to look like a pretty good acquisition -- maybe they still overpaid, but it's performing very well. On the call this morning, banking analyst Mike Mayo was asking, "Is this the strongest margins we've seen in the wealth-management business since the heyday, since Merrill Lynch's old heyday?" [CEO Brian] Moynihan and Bruce Thompson, the CFO, didn't give a direct answer to that, but they certainly hinted that the Merrill Lynch wealth-management business is performing very, very well.
The trading business was also strong, and we just continue to see credit improvement in the consumer portfolios, in the commercial portfolios, that Bank of America holds on its books -- so there are certainly some things to like on the business perspective.
I also was encouraged by some of comments that Moynihan and Bruce Thompson said on the call this morning. Instead of skirting around these other unrealized losses on the security portfolio, they acknowledged these losses at the beginning of the call, instead of kind of shooing them off to the side, kind of like [JPMorgan Chase] did earlier in the week -- they didn't fully address these head-on at the beginning; some analysts had to bring it up, and then they addressed it. Bank of America, they addressed these losses upfront. They said "We made $4 billion in net income, but these were offset by unrealized losses," so they were upfront about that. They didn't try to hide it.
They also acknowledged the new leverage ratios, the proposal in capital requirements that some the banks will have to hold in the long run. They addressed those upfront. They told analysts where they stood on that. They weren't trying to be opaque and not address that upfront. So I was encouraged to see that. And then just the overall performance -- yes, the net income was wiped out by unrealized losses to some extent, but, but, the long-term view of Bank of America is why you'd buy it today is because ultimately their returns are going to get back to a normalized level when they get through these legal issues, when they get through credit losses. They can return to a double-digit return on equity, and they were close -- they were almost at a 10% return on tangible equity in the second quarter.
So, that's them trying to prove investors and analysts right. The people who bought their stock over the last year, the last couple years, despite making terrible net income results and terrible returns for shareholders, the view was Bank of America will ultimately return to a normalized earnings stream and slowly try to produce double-digit returns on equity, and that's where the real value is going to be for a Bank of America shareholder. So, they're trying to prove investors right. They're on the path to do that. There's still going to be some bumps in the road -- we still have legal settlements outstanding -- but the road looks like it's clearing a little bit for Bank of America, and it was a pretty positive quarter.
Again, this is David Hanson, and you can always read more on Fool.com.