Bank of America (BAC - Free Bank of America Stock Report), one of the largest banks in the United States and a Dow-30 component, turned in a much better-than-expected March-quarter operating performance, although it reported earnings of only a few pennies a share. The stock initially surged more than 4% on the earnings news, but later gave up most of the gain, as investors took a closer look at the company's results.

Reported earnings came in at $0.03 a share, below our estimate of $0.07 and the $0.17 logged in the opening quarter of 2011. As usual, earnings included a number of items that are unusual or occur infrequently, that we estimate together reduced earnings by a net $0.22 a share, including negative valuation adjustments related to narrower credit spreads that lowered earnings by $0.28. Similar valuation adjustments lowered earnings in the year-earlier period by $0.06.

Earnings in the quarter benefited from relatively strong mortgage and trading revenues, but new regulations depressed card and service charge income. Net interest revenue improved on a sequential-period basis, reflecting lower premium and hedge accounting costs, reductions in long-term debt, and lower deposit rates. But low interest rates, declines in consumer loans, and the sale of a Canadian card business held net interest revenue below the year-earlier tally.

Meanwhile, an accounting change related to home equity loans increased problem assets relative to the 2011 yearend level. Absent this item, problem assets would have continued to moderate. Earnings benefited from a $1.1 billion reduction in the loan loss reserve in the quarter. In addition, the company trimmed operating expenses despite increased incentive and retirement expenses.

While the company is clearly making earnings progress, it still has a long ways to go. Over the next few quarters, we expect net interest income to roughly match the March-period tally absent the positive swing in hedge and premium costs recorded in the March period. Trading revenue is somewhat volatile, and may fluctuate from quarter to quarter. But we don't expect additional valuation adjustments to reduce revenues. Although problem assets probably will continue to trend lower, reductions in the loan loss reserve are likely to be smaller going forward.

In all, the company's year-ahead earnings prospects will depend heavily on its ability to further lower operating expenses under its New BAC profit improvement program, and reduce costs as it resolves mortgage-related issues. We assume it will continue to make good progress on this front and are raising our share-net estimate for 2012 (which includes the March-quarter valuation adjustments) from $0.50 to $0.80. Looking ahead to 2013, we are tentatively introducing an earnings estimate of $1.25 a share. 

Our stance on the stock remains unchanged. Although BAC shares have good 3- to 5-year recovery potential, the company is still working its way through mortgage repurchase claims and litigation, and faces a still difficult interest rate and regulatory climate. In spite of the earnings improvement that we look for and recent progress in improving liquidity and strengthening its capital ratios, we don't expect a dividend increase this year. All but aggressive investors may want to remain on the sidelines for now.

About The Company:Bank of America was formed by the merger of NationsBank with BankAmerica in September of 1998. As a financial holding company, it provides banking and financial services to individuals, corporations, and governments worldwide. Acquisitions over the years include FleetBoston Financial, MBNA, LaSalle Bank, Countrywide, and most recently, Merrill Lynch. In total, the bank has about 6,000 offices in 29 states & Wash. D.C.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.