Paulson Parries Politicians
Guessing at how Bank of America ( BAC) truly performed last quarter seems to be a fool's game.
Wall Street analysts who get paid to do just that have become more bullish on the stock over the past month, sending the average estimate up a penny to 11 cents per share. But while 10 of those profit soothsayers have raised estimates, another four have lowered them. Expectations now range from a loss of 25 cents per share to a profit of 38 cents per share. The wide gap reflects the fact that BofA -- as the largest bank in the nation and a major player in all sorts of financial services -- is hugely exposed to both the upside and downside of this rollercoaster recession. Whether the peaks outweighed the dips during the second quarter is hard to say. "In general, the large banks that I follow, the second-quarter numbers are going to be pretty messy," says Matthew Ko, an equity analyst at Profit Investment Management, citing capital raises, asset sales, FDIC assessment fees, asset mark-ups, and several other factors. "Throwing that all out and trying to come up with an earnings number has been a real problem."
Ko doesn't expect earnings to stabilize until late 2010 at the earliest. For now, the analyst, who calls himself "the biggest bear," is focused on bank balance sheets to determine whether credit issues are stabilizing or spreading up further into higher-quality borrowers, and whether capital levels are adequate to handle the implied result.
BofA's profit, as well as those of large-cap banking brethren, were due to the refinancing boom, a steep yield curve, improvements in the capital markets, an ease in accounting standards and some special one-time gains. "I do expect like last quarter that bank earnings will be better than expected," says Mickey Cargile, managing partner of WNB Private Client Services. "Whenever we get in a down cycle like this, it takes investors longer to trust expectations and they start discounting and get too pessimistic." Indeed, many of those profit-driving factors remained in place during the second quarter, including low-cost funding from government loans and guarantees. The Dow Jones Industrial Average rose 11% and the debt markets began to ease. BofA's capital markets business surely benefitted from those trends, as did the company itself. BofA was required by regulators to lift its own Tier-1 capital levels by
over $33.9 billion. BofA surpassed that goal by completing a mammoth stock offering, several exchanges of preferred stock for common equity, and a reported sale of $7.3 billion in China Construction Bank stock. And while Bank of America has faced a good deal of stress from its acquisitions of Countrywide and Merrill Lynch, those two entities have the potential to help boost results in the current environment. Owning the country's biggest mortgage lender is not a bad thing when a government-sponsored refinancing boom turns it into a profit center. Merrill-related headaches haven't abated, and some have intensified. But the investment bank and what remains of its thundering herd of brokers provided BofA with plenty of opportunities to make money last quarter. Without it, Bank of America would only have earned $500 million during the first quarter.
As the credit markets thawed, some of the bad debt BofA inherited from those two companies stood to gain value as well, depending on how far the assets were written down. Morgan Stanley analyst Betsy Graseck expects BofA to book a $713 million increase on debt valuation in its investment banking division. That gain would be due in part to a 9% write-up of "toxic" legacy assets. Still, anyone seeking gains from BofA-Merrill's capital markets business should also factor in the volatility of those results. After all, this apparently positive quarter -- at least judging from
Goldman Sachs ' ( GS) 65% profit increase -- was preceded by a few quarters of incredibly severe stress. Ko says a more positive signal of bank health would be net-interest margins that increased from low-cost, core deposits, rather than so-called "hot money" CDs that offer attractive interest rates. TARP payoff , changes to executive ranks, or further asset sales that are part of the bank's capital-raising effort. The government still holds a $45 billion stake in Bank of America preferreds, not to mention the warrants that come along with the investment. BofA has not been approved to pay back those bailout funds yet, and investors are eager to find out when it will apply to do so, though few expect BofA management to provide a clear answer. But while remaining under the government's wing -- or paying $713 million in TARP dividends last quarter -- isn't viewed as a good thing, it might not be all bad.
"I assume those banks that haven't paid back TARP are employing that TARP money profitably," says Cargile. "The ones that paid it back are the ones that didn't really need it. The ones that haven't put it back, they have it in the marketplace and are making profits." After a
board-room shuffle , some top-level executive changes, and a slew of reports about Merrill superstars leaving -- only to be followed by announcements of new superstar hires -- it won't be surprising to hear of more transition. CEO Ken Lewis has said he plans to stay at the firm until BofA starts repaying TARP funds, but there's no guarantee his tenure won't be shortened by calls for his ouster . But not everyone shares that view. "Reports that the bank is seeking a replacement for Ken Lewis as CEO are undoubtedly false," Richard Bove, a bank analyst with Rochdale Securities says in a recent report. "Should Mr. Lewis wish to be CEO of this company when he is 96, in my view, he will be CEO of this company when he is 96." Bank of America may also report progress on its planned sale of First Republic Bank, as well as its possible sale of Columbia Management, other businesses and joint ventures. Other significant items that BofA hasn't dropped any clues about yet are anyone's guess. "I think we could see some positive surprises at the large banks," says Len Blum, managing director of Westwood Capital. "The expectations are pretty low, so it wouldn't be surprising to see banks beat expectations."
Still, Blum notes, it's "really going to be a 'devil in the details' kind of quarter."