Bank of America (BAC) swung to a profit in the second quarter largely by slashing expenses and releasing reserves, but the nation's second-largest bank remains hobbled by continued repurchase requests on soured loans.
In a conference call Wednesday, Brian Moynihan, B of A's chief executive, faced repeated questions about whether the company has set aside enough reserves to cover a 40% jump in repurchase claims from the first quarter, to $22.7 billion.
"We're fighting the trend with all the arrows in the quiver that we have," Moynihan said.
B of A reported net income $2.5 billion compared with a loss of $8.8 billion a year earlier. Revenue fell slightly from the first quarter, to $21.9 billion, up 66% from a year earlier.
On the bright side, the Charlotte, N.C., bank trimmed overhead by about 26% as part of its ongoing effort to streamline operations that it says will save it $3 billion a year. It also and reported strong results in mortgage banking, card income and capital levels. Overall, its earnings per share of 19 cents beat consensus analysts' estimates by four cents.
Still, analysts harped on the increase in demands from mortgage insurers and bond investors as proof that the bank has not set aside enough funds to deal with problem loans, primarily those inherited from Countrywide Financial.
"The thing that's holding Bank of America back is their repurchase reserves, which are $7 billion less than their outstanding claims," says Erik Oja, an equity analyst at S&P Capital IQ. "Unless they can beat down these outstanding claims, they have to put more into reserves, which is a big hit considering they earned $2 billion in the quarter."
B of A had already set aside roughly $14 billion for repurchase claims a year ago, Oja says.
On top of the increase in claims from private-label bond insurers, B of A faces a deluge of claims from Fannie Mae. In late January, Fannie cut off B of A from selling most types of loans because of delays in making good on outstanding buyback requests.
B of A said in its earnings release that because of its "continued differences" with the government-sponsored enterprises on "each party's interpretation of the requirements governing contracts, it is not possible to reasonably estimate the outcome or range of possible loss may be."
Not all analysts are convinced B of A has under-reserved.
"I would argue that the actual putbacks are expected and what's unexpected is this is the only bank not working with Fannie," says Jefferson Harralson, a managing director and bank analyst at Keefe, Bruyette & Woods. "They say Fannie is too aggressive at putting back and the loans are decently underwritten and have paid for two years and Fannie is saying that there was something in the underwriting that didn't match up and they are fighting over it."
Another swing factor is B of A's $8.5 billion proposal to settle mortgage-backed securities claims with 22 major investors, including BlackRock Inc. and the Federal Reserve Bank of New York. Harralson says that if the settlement wins court approval, B of A's repurchase reserves "should be unchanged."
B of A had some strong signs of growth, including an 18% jump in mortgage originations, to $19 billion, in the second quarter, and a 7% increase in new credit card accounts from a year ago.
B of A also has made significant progress in reducing risk-weighted assets and thus boosting its Tier 1 common capital ratio, to 8.1% as of June 30. "In one year, our Tier 1 common capital ratios have gone from being the lowest of the major U.S. banks to among the highest," Bruce Thompson, B of A's chief financial officer, said on the call.
Small- business loans were also a bright spot, as balances rose 23% from a year ago, to $4 billion.
The bank says it is recapturing some retail market share after exiting the correspondent lending business late last year and that its credit card loss rate is the lowest since the fourth quarter of 2007.
Moynihan also seemed particularly pleased with the 34% increase in mobile banking customers, to 10.3 million, year over year.
"The mobile platform growth has changed our thinking," he said in response to a question about whether B of A is coming out with new account offerings and products. "It's a much more efficient and strong service model," Moynihan added.
Oja at S&P expects B of A will continue to boost earnings for the next six quarters, though he says half of its profits will come from reserve releases. He says about 14 cents of the bank's profit in the second quarter came from lowering the allowance for loan losses, largely due to improved credit quality. .
Paul Miller, managing director of FBR Capital Markets, says use of reserves to boost earnings was "more so than I would have thought in this side of the cycle."
"Regulators are letting the companies lower reserves more than I thought, especially with the probability of a recession growing every day," Miller says.
In addition, analysts appeared to be disappointed with the timing of expense savings, which could be attributed to the $2.6 billion in noninterest expense for legacy assets and servicing, including new servicing standards that came out of the national mortgage settlement earlier this year with state attorneys general and federal regulators.
Harralson at KBW says expenses will drop by as much as $9 billion once B of A works through what he calls the "review and punish stage," which includes expenses for foreclosure reviews that have been required by the Office of the Comptroller of the Currency.
"Even though they are seeing improved credit quality, expenses are lagging because there's a time lag in working out problem home loans including a lengthy foreclosure process," he says.
Going forward, B of A says it is on track to exceed the 20% targeted reduction in expenses by the end of the year.
"There's nobody working harder to get this number down than we are," Moynihan said of expenses.