Legal Costs Eclipse BofA’s Decent Operating Performance Yet Again in Q2

Bank of America’s (NYSE:BAC) earnings release for the second quarter of the year on Wednesday, July 16, showcased a recurring trend seen in the banking giant’s quarterly results since early 2011 – an otherwise stable operating performance marred by billions in legal costs. ^[1] As the prolonged low-interest rate environment and poor global debt trading activity forced investors to set their expectations for the country’s largest banks quite low, Bank of America comfortably beat revenue and earnings estimates. But investors are not too happy that the bank has been unable to settle its mortgage-related issues with federal and state regulators. The bank set aside $4 billion in legal reserves for the quarter to cover its latest settlement bid of $13 billion, but regulators are pushing for an even larger figure. ^[2] This is because the bank will have to incur an additional multi-billion dollar legal charge for the quarter in which the deal is actually reached – most likely in Q3 given that Bank of America looks keen on resolving its last major legal overhang.

Bank of America had some good news to give investors, though, as it settled its long-standing litigation with AIG for $650 million. The bank also bucked the trend among the investment banks of a year-on-year decline in FICC (fixed-income, currencies and commodities) trading revenues for the second quarter by reporting a 5% growth compared to Q2 2013. Also, its wealth management operations churned out a record performance with revenues crossing $3.1 billion for the first time.

We maintain a $18.50 price estimate for Bank of America’s stock, which is about 20% ahead of current market prices.

See our full analysis for Bank of America’s stock here

FICC Trading Revenues Beat Industry Trends for Second Consecutive Quarter

Bank of America reports the performance of its trading operations as a part of its Global Markets operating division. Excluding the impact of the accounting charge related to CVA/DVA, the bank’s FICC trading desk reported revenues of just under $2.4 billion for the second quarter – 20% lower than the $2.9 billion figure for the previous quarter but 5% higher than the $2.3 billion reported in the year-ago period. These results come in spite of the significantly lower level of activity in the global debt market in Q2 2014 compared to Q2 2013 – enough for rivals Citigroup and JPMorgan to issue warnings about a marked decline in trading revenues for the second quarter. ^[3] Although not quite drastic as initially estimated, both banks as well as Goldman Sachs reported a year-on-year decline of between 10-15% in FICC trading revenues.

This strong Q2 performance follows another revenue beat in Q1, when FICC revenues were identical to the figure a year ago, although JPMorgan and Citigroup reported revenues that were 15-20% lower. Taken together with the 10% lower revenues for the equities desk, Bank of America reported total trading revenues which were equal to those seen in Q2 2013.

Global Wealth & Investment Management (GWIM) Division Continues its Record-breaking Run

Bank of America’s wealth management operations may not be responsible for driving the top line as aggressively as its trading operations, but it definitely provides the bank’s diversified business model a steady and reliable revenue stream – one that has anchored results for several quarters now. As can be seen in the chart above, we attribute roughly 13% of Bank of America’s total share value to its wealth management operations. The division roped in a record $4.6 billion in revenues for Q2 – a little more than 21% of the bank’s total revenues. Improved market valuations of securities coupled with a steady inflow of fresh assets helped the bank shore up a record $2.47 trillion in client balances by the end of the quarter. The revenue benefits did not reflect in the pre-tax income figure, though, as higher performance-related employee payouts and restructuring costs more than cancelled out top line improvements.

The quarter was also the most productive for Bank of America in terms of the “Financial Advisor Productivity” metric it reports. This metric captures the ratio of annualized revenues for the division to the total number of advisors and it stood at $1,060 for Q2 – the highest level this metric has reached since Bank of America acquired Merrill Lynch in September 2008.

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1. Q2 2014 Earnings Release, Bank of America Press Releases, July 16 2014 [↩]
2. BofA Offers $13 Billion to Settle U.S. Mortgage Probe, The Wall Street Journal, July 16 2014 [↩]
3. Citigroup Trading Revenue Will Likely Drop Further, CFO Says, The Wall Street Journal, May 27 2014 [↩]