Bank of America Sells Off as Skeptics Question Earnings Quality

Bank of America (BAC Quote) hit its fourth-quarter profit estimate Tuesday, but some observers say it did so in the same way Linda Tripp recently remade herself, with a nip here and a tuck there.

As a result, analysts and investors who believe Bank of America artificially beautified a not-so-pretty quarter are now wondering whether the bank can achieve its goal, announced at a Tuesday conference call, of increasing profits 12% to 15% in 2000.

On Tuesday, Bank of America stock skidded 2 1/2, or 5%, to close at 48, as bank stocks fell 2.1%, going by the KBW Bank Index.

Hold the Mayo

The nation's second-largest bank, with $633 billion in assets, reported fourth-quarter operating earnings of $2.12 billion, or $1.23 per fully diluted share, marking a 35% rise from the $1.6 billion, or 91 cents per share, it earned in the year-ago period. But the bank would have missed the $1.23 estimate supplied by analysts surveyed by First Call/Thomson Financial had it not been for one-time gains that added as much as 11 cents per share in earnings, according to Mike Mayo, banks analyst at Credit Suisse First Boston, which rates Bank of America a hold and hasn't done recent underwriting.

If the bank had done without a $91 million gain from credit card and other consumer finance asset sales, and kept its venture capital gains at their "normal" level, then it would have made just $1.18 per share, Mayo wrote in a research note. Further, if the bank had played it safe and made a fourth-quarter loan-loss provision that equaled the quarter's reserve for loan losses, the per-share number would've been another 6 cents lower at $1.12, Mayo argued. The bank booked $350 million of provisions in the fourth quarter, vs. net charge-offs of $501 million.

Mayo's "entitled to his opinion," says a Bank of America spokesman. "The reasons [for the $91 million gain] were strategic," he adds, explaining that the card sale was done as part of the bank's continuing efforts to get rid of cards that don't come under the Bank of America brand.

Hanceforth

And on the conference call, James Hance, the bank's finance chief, said the fourth-quarter provision's level was justified because the bank is "overreserved." Hance explained that the bank is shifting emphasis onto lower-risk businesses -- like residential mortgages, as opposed to commercial and foreign lending -- and still has a significant reserve cushion for potential future losses. Hance added that the bank should no longer suffer "charge-offs of size" among loans to healthcare companies, a troubled sector which the institution has had heavy exposure to.

It looks like the nonrecurring items and the low provision were done to make up for the poor performances in the bank's core operations, says Andrew Collins, banks analyst at ING Barings Furman Selz, which rates the bank a hold and has done no underwriting for Bank of America. Collins, who Tuesday cut his 2000 earnings forecast to $5.30 per share from $5.40, notes three areas where the bank disappointed him. Fourth-quarter noninterest income of $3.6 billion was below the third-quarter's $3.73 billion. Fourth-quarter expenses of $4.55 billion were actually higher than the third quarter's $4.53 billion. And the net interest margin -- the percentage difference between interest earned on loans and interest paid on deposits and borrowed funds -- shrunk to 3.32% from 3.46% in the third quarter. "That's a pretty big drop," says Collins.

And Collins isn't buying Hance's explanation on provisions. Collins says that at a time when credit quality is gradually deteriorating across most of the banking sector, making provisions lower than charge-offs "is a big no-no." The bank's nonperforming assets jumped 5.5% to $3.21 billion in the fourth quarter from $3.04 billion in the preceding period.

Paper Chase

And there were other areas of concern. Net income at the bank's consumer banking division dropped to $951 million in the fourth quarter from $1.1 billion in the third. And despite a heavy hiring spree that eroded efficiency at the global corporate and investment banking division, income from investment banking fell to $599 million in the fourth quarter from $702 million in the third quarter, a period when other banks made huge gains from capital markets. In addition, the unrealized, or paper, loss on the bank's largest securities book ballooned to $3.8 billion in the fourth quarter from $2.9 billion in the third.

As for 2000, Bank of America's aim of increasing earnings by 12% to 15% in 2000 looks hard to achieve, says Tom Brown, chief executive of BankStocks.com, a Web site devoted to comment on financial institutions. Brown wonders where this growth will come from if the bank, as Hance stated, plans to expand mortgage-lending, which Brown says is not a high-margin business. Brown also notes that Bank of America's securities portfolio is growing at the same time as its debt is going up, suggesting the bank is borrowing funds in the market to buy bonds, another low-profitability activity in his view.

But the spokesman says the bank can make higher returns on its mortgage business in 2000, and expects this segment's net interest income to rise by 1% to 2% in 2000. And he says the increase in the securities portfolio in the fourth quarter is half the result of higher securitization and says the other part of the rise is offset by reduction in the bank's portfolio of swaps, which are agreements between two counterparties to exchange a fixed-interest payment for a floating-rate one.