Bank of America (BAC - Free Analyst Report), the largest bank in the United States as measured by assets, earned $0.27 a share in the September quarter before a $1.04-a-share noncash, nontax-deductible accounting charge resulting from limits on future debit interchange fees under financial reform legislation enacted in July. The company's performance compared very favorably with the $0.26 loss logged in the year-earlier period and our estimate of earnings of only $0.15. We are excluding the noncash charge in our presentation.

Loan losses declined for the second consecutive quarter, mostly in consumer lending, and earnings included a $1.8 billion reversal of the loan loss reserve. Net interest income rose year to year, aided by accounting rules that resulted in a larger balance sheet, but it declined 4% on a sequential basis, reflecting spread compression in the very low interest-rate environment. Card revenue was hurt by lower credit card interchange revenues and the implementation of the CARD Act. Service charge income also declined as a result of the implementation of new financial reform rules, while trading income moderated. Mortgage revenues rose due to increased core production. At the same time, the costs of buying back securitized mortgages from government-sponsored entities and other investors declined. The company is making progress resolving repurchase claims (thus far, $18 billion) on mortgages originated between 2004 and 2008 and sold to government sponsored entities ($1.2 trillion sold). Claims by other mortgage investors (to which $910 billion of mortgages were sold) total only $8.7 billion up to this point. Meanwhile, excluding the large accounting charge, operating expenses rose 3% year to year due to higher personnel and litigation costs. However, these expenses are down nearly 3% from the June interim.

Looking ahead, we expect Bank of America's credit costs to recede further over the next several quarters. But the company faces a number of headwinds. Sluggish loan demand and very low interest rates probably will exert a little more pressure on net interest income. It will take a number of quarters for new strategies (concerning the way customers pay for bank services) to mitigate the decline in service charge and credit card revenues likely to result from the full implementation of new financial reform regulations. And the costs of buying back previously securitized mortgage loans probably will fluctuate from quarter to quarter.

Due to the better-than-anticipated September-quarter performance, we have raised our share-net estimate for 2010 by $0.15, to $1.05. But we remain cautious and are maintaining our 2011 estimate of $1.45.

We still look for continued credit-quality improvement, increased cross-selling, and efforts to lower costs to support a partial earnings rebound by the 2013-2015 time frame. Furthermore, strategies to offset the impact the financial reform rules will have on revenues and an eventual decline in mortgage repurchase and litigation expenses should also contribute.

The issue has decent 3- to 5-year recovery potential. But this stock is likely to remain volatile in the near term, as developments related to the mortgage foreclosure crisis unfold.

About The Company: Bank of America was formed by the merger of NationsBank with BankAmerica in September of 1998. As a financial holding company, it provides banking and financial services to individuals, corporations, and governments worldwide. Acquisitions over the years include FleetBoston Financial, MBNA, LaSalle Bank, Countrywide, and most recently, Merrill Lynch. In total, the bank has about 6,000 offices in 29 states & Wash. D.C.


At the time of this article’s writing, the author did not have positions in any of the companies mentioned.