Why Bank of America's Investors Can Breathe a Sigh of Relief

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If you're an investor in Bank of America , the Federal Reserve's most recent round of stress tests should serve as a partial affirmation of your patience in the company. Released yesterday, the nation's second largest bank by assets emerged from the central bank's gauntlet in markedly better shape than it did last year. The charts and discussion below examine how the company's capital and earnings held up under the Fed's "severely adverse" economic scenario.

The purpose of the stress tests is to gauge how the capital bases of the nation's largest financial institutions hold up in the face of economic and financial turmoil. Among other things, the most extreme case assumes that real GDP declines an average of 4% this year, unemployment ratchets up to 12.1% by the second quarter of next year, and home prices plummet by 20% over the next 24 months.

As you can see in the chart below, B of A's Tier 1 common capital ratio held up admirably in light of these assumptions. Starting from 11.4% at the end of last September, it bottomed out at 6.8% over the hypothetical time period extending from the fourth quarter of last year through the end of 2014. While that equates to a 40% decline, the ending figure nevertheless comfortably exceeded the Fed's 5% reference rate. By comparison, the average Tier 1 common capital ratio of the 18 institutions tested fell by a third, down to 7.4%.

Source: Federal Reserve.

With respect to net income, B of A didn't fare as well. Its hypothetical pre-tax loss for the nine-quarter time period came in at $51.8 billion. This greatly exceeded the 18-institution average loss of $10.8 billion, and made B of A the worst performer in this regard. Conversely, the Bank of New York Mellon fared the best, with $5.5 billion in earnings despite the assumed economic Armageddon.

Source: Federal Reserve.

Breaking this down a bit further, as you can see in the figure above, B of A's $24.1 billion in pre-provision net revenue was more than consumed by loan loss provisions -- that is, money set aside to cover future losses from soured loans. These accounted for $49.7 billion in losses. In addition, estimated losses from trading added up to $14.1 billion, and "other losses" ate up an additional $13 billion.

And digging into the loan losses specifically, B of A's were widely dispersed among customer and product types. A full 43% derived from residential real estate, 27% from its credit card operations, and a total of 23% from various types of commercial lending.

Source: Federal Reserve.

At the end of the day, the stress tests are meant to do exactly what the name implies: stress you out. And while this year is no exception, investors in B of A should take comfort in the increasingly massive capital hoard sitting on the bank's balance sheet.

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The article Why Bank of America's Investors Can Breathe a Sigh of Relief originally appeared on Fool.com.

John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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