Cost Management, Strong Consumer Banking Results Drive Bank of America’s Impressive Earnings

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The third quarter of the year was a difficult period for the banking sector, but Bank of America (NYSE:BAC) did well in comfortably beating investor expectations when it reported Q3 results on Wednesday, October 14. [1] While the prevalent low interest-rate environment and the sharp decline in valuation across global securities markets presented considerable headwinds to all banking services, Bank of America fared better than its peers on nearly every front. The core consumer banking division saw a sizable improvement in revenues year-on-year, and revenues for the wealth management and investment banking operations declined less than expected.

Notably, Bank of America posted its lowest non-interest expense figure in five years despite incurring a legal cost of $231 million in Q3 2015 – indicating that its operating margins still have some room for improvement in the near future. At the same time, its total litigation-related costs for the first nine months of 2015 were negligible compared to recent years, indicating that the bank has successfully worked its way through its backlog of legacy legal issues. This, coupled with its strong capital position, would mean that Bank of America can now explore ways to return additional cash to shareholders.

Investors expressed their happiness with the bank’s results by leading its shares up nearly 5% by the end of Thursday. We maintain our price estimate of $19.50 for Bank of America’s stock, which is roughly 20% ahead of the current market value.

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

Trading Revenues Higher Than Initial Estimates

Bank of America reports the performance of its trading operations as a part of its Global Markets operating division. On a reported basis, the bank’s total trading revenues were almost identical to the figure for Q2 2015 as well as Q3 2014. Excluding the impact of CVA/DVA accounting charges, the bank’s fixed income, currencies and commodities (FICC) trading desk reported adjusted revenues of just over $2 billion for the third quarter – 7% lower than the $2.15 billion figure for the previous quarter, and 11% below the $2.25 billion reported a year ago. While weak debt trading activity and increased volatility were expected to have an adverse impact on FICC trading revenues this quarter, Bank of America’s performance is commendable given than rival JPMorgan witnessed a much steeper 23% reduction in these revenues year-on-year.

At the same time, Bank of America’s equities trading desk continued its strong run to churn out more than $1.15 billion in revenues for the third consecutive quarter. Total adjusted trading revenues for the quarter were $3.2 billion – only marginally lower than the $3.3 billion figure for the two comparative quarters. This is a much better performance than the 5-6% year-on-year decline in trading revenues estimated by the bank’s top management in September. [2]

Consumer Banking Division Anchors Results For The Quarter

Bank of America’s consumer banking division, which includes its deposits and consumer lending operations, reported one of its best performances over recent years in Q3 2015 thanks to an increase in service charges as well as card fees. Although recent changes in the bank’s reporting structure makes it difficult to compare results for this quarter with older periods, the division’s total revenues of $7.8 billion were likely the highest since late 2011. This figure represents a 1% improvement year-on-year and a strong 4% increase quarter-on-quarter – a great performance given the pressure on total revenues from lower net interest margins. Card fees gained the most in particular thanks to an increase in outstanding balances as well as payment volumes – witnessing a sequential 4% increase to $1.25 billion in Q3 2015.

While revenues were upbeat for the quarter, the impact on the bottom line was evident due to non-interest expenses decreasing marginally year-on-year. Although these costs increased from $4.3 billion in the previous quarter to $4.4 billion in Q3, the division’s efficiency ratio (defined by the bank as a ratio of non-interest costs to total revenues) fell from 57.2% in Q2 to 56.6%. You can see how an improvement in cost efficiency for the consumer banking division affect’s Bank of America’s share price by making changes to the chart below.

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Notes:
  1. Bank of America Reports Third-quarter 2015 Net Income of $4.5 Billion, or $0.37 per Diluted Share, Bank of America Press Releases, Oct 14 2015 []
  2. BofA Predicts 3rd-Quarter Trading Revenue Will Drop, The Wall Street Journal, Sep 17 2015 []