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The good news for Bank of America with respect to second-quarter earnings is that analysts have set a low bar for the bank to clear in order to beat the consensus estimates. The bad news is that there are stormy skies ahead for the nation's second biggest bank by assets.
On average, analysts expect Bank of America's earnings to fall by 27% compared to the second quarter of 2015. The consensus estimate calls for earnings per share of only $0.33 in the three months ended June 30. In the year-ago period, it earned $0.45 per share.
This isn't as bad as it looks. The second quarter of 2015 was Bank of America's best quarterly performance in almost five years. Fueled by lower legal and operational expenses, the North Carolina-based bank earned $5.3 billion during the three-month stretch, though $700 million of that came from favorable market-related adjustments to its net interest income.
"Solid core loan growth, higher mortgage originations and the lowest expenses since 2008 contributed to our strongest earnings in several years, as we continued to build broader and deeper relationships with our customers and clients," saidChairman and CEO Brian Moynihan at the time. "We also benefited from the improvement in the U.S. economy, where we are particularly well positioned."
But a lot has happened since then. While the Federal Reserve increased interest rates by a quarter of a percentage point in December, it later abandoned any pretensions of going further after jobs growth in May increased at the slowest rate in half a decade.
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This is particularly bad news for Bank of America given that it's positioned to benefit the most of any big bank from an increase in interest rates. The bank estimates that a 100-basis-point (1%) increase in short- and long-term rates would boost its annual net interest income by $6 billion. Without this, there's little hope that Bank of America can earn the 12% or so return on equity that's needed to create value for shareholders.
The vote in the United Kingdom at the end of June to separate from the European Union made things worse. The economic tumult that followed will buttress the Fed's decision to proceed cautiously with rate increases. The vote in favor of Brexit is also likely to weigh on Bank of America's capital markets business -- its trading and investment banking units -- which suffers in the face of excess uncertainty and volatility.
Investors got a taste of this in the first quarter, when concerns about economic growth in China, low oil and gas prices, and the pending referendum in the United Kingdom sent capital markets revenues tumbling across Wall Street. Bank of America led the way with a 16% drop in first-quarter trading revenue, followed by a 13% fall at Citigroup and an 11% decline at JPMorgan Chase.
Fortunately, because the Brexit vote took place in the final two weeks of the second quarter, there's reason to believe that prior forecasts of an improvement in trading income may still have come to fruition. Earlier in the quarter, Moynihan predicted a mid-single-digit year-over-year increase in quarterly trading revenue. Executives at JPMorgan Chase and Citigroup followed with their own predictions of improved trading results.
Analysts nevertheless dropped their earnings estimates for Bank of America in the wake of the U.K. vote. Since the referendum on June 23, analysts have lowered the bank's EPS estimate by 8%. That's a bigger drop than any other bank. The runner-up, Citigroup, saw analysts cut their forecasts by an average of 5%.
There's also reason to believe that Bank of America's earnings will be hit by a $415 million fine from the SEC during the quarter that settled allegations that Merrill Lynch "misused customer cash to generate profits for the firm and failed to safeguard customer securities from the claims of its creditors." The impact on Bank of America's bottom line will depend on whether, and to what extent, it had previously set aside money to cover the settlement.
Like the other major lenders, Bank of America is also facing headwinds from higher losses in its loan portfolio -- and particularly from loans to energy companies, which are struggling against low oil and gas prices. Loan loss provisions in its global banking segment quintupled in the first quarter, going from $96 million in the year-ago period to $553 million in the first three months of 2016.
The one bright spot may be loan growth. "Growth has been more or less strong across the board, including commercial and industrial loans, real estate and credit cards," wrote The Wall Street Journalearlier this month. "As long as the economy keeps chugging along, this should continue."
Either way, it's no longer the current quarter that's on investors' minds, but rather what lies ahead for Bank of America. The bank has taken meaningful strides over the last few years to mop up legal liability and excess costs stemming from the financial crisis -- adding up to $200 billion overall. But even after this progress is taken into account, Bank of America has nevertheless struggled to generate the kind of profitability that investors expect.
Higher interest rates will close much of the gap between investor expectations and Bank of America's actual profitability. But with those now pushed off even further into the future, there's little reason to be optimistic about the bank's short-term prospects -- for either its bottom line or for the still incredibly low valuation on its stock. Its shares trade for a 40% discount to book value. Shares of Wells Fargo, meanwhile, trade for a 40% premium to its book value.
The storyline for Bank of America's investors this quarter is thus much the same: wait and see. There will come a time when the path is clear for Bank of America and other banks to earn a lot more money. As to when that will happen, however, no one knows.
The article Bank of America: Second-Quarter Earnings Preview originally appeared on Fool.com.
John Maxfield owns shares of Bank of America and Wells Fargo. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool recommends 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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