Our Take on Bank of America's Fourth Quarter

 Bank of America (BAC) reported net income available to common shareholders of $85 million, or $0.01 per share, for 2011, in line with our modest expectations. We are leaving our fair value estimate unchanged.

Net interest income increased slightly from the third quarter, aided by a decline in premium amortization and hedge ineffectiveness, as well as reductions in long-term debt balances and the interest rate paid on deposits. Bank of America was not immune to macroeconomic trends, though. Consumer loan balances and yields fell, and the bank also reduced its investments in low-yielding securities. We don't expect these pressures to decline in the near term. Bank of America also experienced the effects of volatile markets in the fourth quarter. Global wealth and investment management income fell $98 million during the quarter despite a 3.5% increase in client balances.

The global banking and markets segment posted a $433 million loss during the quarter on weaker sales and trading revenue, though this included a sizable debit valuation adjustment, which we do not believe is indicative of actual results. We continue to expect an eventual rebound in trading and investment banking revenue, though new regulations are likely to make it difficult for banks to match the peak levels reached before the global financial crisis.

Core operating expenses, including personnel, occupancy, and equipment, fell during the fourth quarter, but total noninterest expenses increased in part due to goodwill impairment, litigation, and FDIC assessment charges. However, the bank has a long way to go in order to reach its goal of $5 billion in annual cost savings by the end of 2013, since we don't expect litigation and default servicing expenses to decline in the near term.

Credit quality continued to slowly improve, for the most part. Nonperforming loans now total 2.74% of total loans and leases, down from 2.87% at Sept. 30 and 3.27% at the end of 2010. The bank did experience a slight uptick in nonperforming home equity loans. We're not yet bullish on the housing market and acknowledge the possibility of further losses in this area, but we'd expect any such direct losses to be manageable.

The bank recorded a reps and warranties expense of $263 million, primarily related to the government-sponsored enterprises. Bank of America estimates that non-GSE exposure could be as much as $5 billion above its current reserves for such losses. Notably, this does not include potential losses due to fraud and other claims. We continue to expect that losses associated with Bank of America's past mortgage-related missteps will be significant.

We're still concerned that such losses will hinder the bank's ability to build capital over the next two years. The bank is forecasting a Basel III Tier 1 common equity ratio of 7.25%-7.50% by the end of 2012. If this goal is not reached, Bank of America could end the year well behind its peers in terms of capital levels, many of which have already reached this level. The bank reported a tangible common equity ratio of 6.64% at year-end. While this level is not troublesome at the moment, Bank of America will need to ensure it does not fall further behind more profitable competitors in 2012, in our view. Despite posting a small profit for the quarter and the year, the bank has its work cut out for it as it attempts to meet its cost of capital and achieve even a modest 1% return on average assets without diluting shareholders in the meantime.

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