Cutting Through the Noise of B of A's Earnings

For the average investor, trying to decipher an earnings report from any of the too-big-to-fail banks is like translating ancient Egyptian hieroglyphics without a guidebook.

Earlier this morning, the nation's second largest bank by assets, Bank of America (NYS: BAC) , reported its results from the third quarter. While the megabank ostensibly beat analysts' estimates on the bottom line, its shares nevertheless began the day in the red. What gives?

Cutting through the noise of B of A's earnings
The most widely cited numbers from B of A's third quarter are naturally its revenue and net income. For the three months ended Sept. 30, the bank reported earnings of $340 million on $20.7 billion in revenue, compared to the same quarter last year, in which it earned $6.2 billion on revenue of $28.7 billion.

Although the former figures are alarming at first blush, there are two things to note. First, B of A recorded a number of charges last quarter that affected both metrics in a negative way. Among other things, it recorded a $1.6 billion litigation expense after settling a class action lawsuit involving its acquisition of Merrill Lynch, and notched a $1.9 billion non-cash charge related to improvements in the valuation of its debt. And second, in the same quarter last year, B of A recorded an analogous but positive $6.2 billion non-cash charge related to the then-deterioration of its debt valuation. Once these differences are normalized, the year-over-year disparity effectively evaporates.

With respect to revenue, B of A telegraphed a number of positive signals. On the traditional banking side, like JPMorgan Chase (NYS: JPM) and Wells Fargo (NYS: WFC) , it notched a double-digit increase in mortgage originations over the prior quarter, funding $20.3 billion in residential first mortgages over the three-month time period. Although this fell short of JPMorgan's $47 billion and Wells Fargo's astounding $139 billion in mortgage originations, it was nevertheless a step in the right direction.

Added to this was a 17% sequential uptick in revenue from its investment bank -- on a year-over-year basis, the increase was an astounding 42%. To give you some context, while Goldman Sachs (NYS: GS) also reported strong year-over-year investment banking revenues, on a sequential basis, its figure actually declined relative to the second quarter.

On the expense side, meanwhile, the bank continued to forge ahead with its Project BAC, under which it plans to cut expenses by upwards of $8 billion on an annual basis over the next few years. Compared to the same quarter last year, employee count was down by 5.6% and it shuttered 175 of its worst-performing banking centers. All told, comparable noninterest expenses decreased an impressive 6.7%.

Perhaps most importantly, both credit quality and capital levels, B of A's Achilles' heels, improved across the board. Excluding the impact of new regulatory guidance, the bank reported decreases in net charge-offs, delinquent and nonperforming loans, as well as its quarterly provision for credit losses, which fell by more than half on a year-over-year basis. In addition, its Basel III Tier 1 capital ratio improved to 8.97%, up from 7.95% in the second quarter. According to B of A's chief financial officer, Bruce Thompson, "With these gains, we have turned our attention to driving core earnings."

Last but not least, I certainly wouldn't want to leave you without an appreciation for the biggest risk facing B of A. As I've discussed before, over the last few quarters, past investors in mortgage bonds sold by the former ne're-do-well Countrywide Financial, which B of A purchased in 2008 for $4.1 billion, are demanding that the bank repurchase the now-souring bonds. These claims have more than doubled over the last 12 months, going from $10 billion in the third quarter of 2011 to $25.5 billion currently. And in the last quarter alone, there were a total of $5 billion new claims.

To say that this is a big problem for the nation's second-largest bank by assets would be an understatement, as a wholly non-favorable outcome to the ongoing dispute over liability for the bonds, at the very least, will delay capital distributions to shareholders for the foreseeable future.

The Foolish bottom line
All things considered, while its unadjusted top-line figures weren't anything to write home about, B of A's third quarter evidenced further progress by the bank of putting its lamentable past behind it. This is one of the reasons I remain bullish on its stock. For a handful of other reasons, as well as a further examination of the risks it faces, download our new in-depth report on Bank of America. Among other things, it articulates the reasons that shares in the lender could "double or triple" over the next five years. To see why, simply click here now.

The article Cutting Through the Noise of B of A's Earnings originally appeared on Fool.com.

John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Wells Fargo. Motley Fool newsletter services recommend Goldman Sachs and Wells Fargo. 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.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.