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Is The Worst Over for Bank of America (NYSE:BAC)?

Bank of America

Bank of America (NYSE:BAC) reported earnings for the first quarter today, but they came in below analysts expectations, with the strong dollar and continued low interest rates being blamed for the disappointing performance.

Bank of America

The Charlotte NC based bank did report a profit of $3.36 billion, for the quarter, up from a loss of $276 million for the first quarter of 2014.

But overall revenue was down 5.9% to $21.42 billion. The fall is particularly disappointing considering both J.P Morgan Chase and Wells Fargo & Co both reported increased revenue Tuesday.

Overall there was nothing to get too exciting about, Bank of America is in a transition period following a disastrous year in 2014, which saw profits fall 58% on the back of huge litigation charges stemming from its purchase of Merrill Lynch and Countrywide Financial.

Low interest rate hurts Bank of America bottom line

The low interest rate environment is weighing on profits across the banking sector. BofA reported that income generated from its loan portfolio fell to $9.45 billion down from $9.64 in the fourth quarter of 2014.

The bank has said previously that if short-term interest rates were to rise by 1 percentage point it would increase net interest income by around $3.7 billion a year.

BofA’s loan portfolio took a bit of a hit this quarter, falling to $877.96 billion from $881.39 billion last quarter and down from $916.22 billion twelve months earlier.

But an increase in home refinancings allowed the bank to extend $13.7 billion in mortgages for the quarter. Thats up from $8.85 billion in the first quarter of 2014. Bruce Thompson BofA’s chief financial officer described the mortgage business as “encouraging”.

FX one bright spot in disappointing trading performance

Foreign Exchange (FX) trading continued to perform well in the first three months, recording its highest revenues since BofA acquired Merrill Lynch in 2007, more than doubling revenue received from the same period last year.

The bank said that increased revenues in the department are a combination of the European Central Bank’s quantitative easing program and investors’ ongoing appetite for the U.S. dollar.

However, the increase in FX revenue wasn’t enough to offset a decline in its trading revenue, which fell by 5.1% to $3.9 billion down from $4.11 billion in the first quarter of 2014.

Costs continue to fall

Bank of America CEO Brian T. Moynihan is continuing with his cost cutting program. Operating costs continued to fall in the quarter down to $15.7 billion from $22.4 billion for the previous year.

While costs in the banks legacy assets and servicing division fell from $1.6 billion in the first quarter of 2014 to just $1 billion in the same period this year. The bank reported that the number of mortgages which had fallen more than 60 days behind on re-payments had fallen to 153,000 down from 277,000.

The bank is also reducing overheads by cutting back both staff and branches, with the number of full-time employees falling by 1.8% in the three months to March. BofA now employs just 219,658 full-time staff. A level not seen since before the purchase of Merrill Lynch and Countrywide Financial, which added over 100,000 employees to the payroll.

Legal woes are behind Bank of America

In common with most large financial institutions Bank of America has paid out billions to resolve litigation, much of it stemming from subsidiaries Countrywide Financial and Merrill Lynch.

Last year the bank made a $16.65 billion settlement with the U.S. government over toxic mortgages sold by Countrywide Financial. The settlement resolved a large amount of the banks outstanding mortgage-related legal problems. Legal expenses for the quarter fell to $370 million down from $6 billion in the first quarter of 2014.

Fines and settlements have so far cost BofA around $70 billion since the start of the financial crisis. Shareholders will be pleased to note that the bank says most of its legal woes are now behind it.

Issues with Fed stress test

BofA surprised analysts last month when it disclosed that the Federal Reserve found “weaknesses in certain aspects of the bank’s loss and revenue modeling practices and in some aspects of the BHC’s internal controls” during its annual “stress test” which is designed to determine the amount of losses the bank would suffer in a number of hypothetical downturn scenarios.

BofA Chief Financial Officer Bruce Thompson told reporters this morning that that the bank’s stress-test submission had met the Fed’s requirements on the basis of measuring capital levels. But the Fed had told the bank that it found weaknesses in the way the bank models for loss and revenue.

Despite these issues the bank was given conditional approval to buy back $4 billion of common stock, providing the bank resubmits its capital plan by the end of the third quarter. Should the bank fail to resubmit, the Fed can freeze any capital distributions.

BofA CEO Brian Moynihan announced today that the resubmission process would be handled by longtime lieutenant and former Chief Risk Officer, Terry Laughlin. The bank also said that it had hired a third-party firm to look over its processes to identify areas that require strengthening.

Light at the end of the tunnel

Despite today’s disappointing results, there are signs the worst is over. With the U.S. economy further along the road to recovery than most other developed economies and the possibility of higher interest rates around the corner. Analysts say 2016 is shaping up to be a better year for banking stocks.

The few remaining litigation problems that remain at Bank of America should be resolved by the first quarter of 2016. While the U.S. economy will continue to strengthen, albeit more slowly than previously predicted.

Currently Bank of America has an attractive valuation compared to other major U.S. banks. Much of that is to do with a lower return on its assets. But with most of its legal woes behind it, the bank should have turned the corner now.

David Hilder, banking analyst at institutional broker-dealer Drexel Hamilton told CNBC this morning that he favored shares of Bank of America above other bank stocks over a one-year time frame.

“It’s a great franchise, they’re bringing down expenses, and it’s probably the cheapest stock among its peers,” he said.

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