Bank of America's Big Puzzle

Investors hope the financial giant's traditional banking operations can help counter ill effects from the credit crunch

Few are sure of what to expect Oct. 18, when the largest U.S. retail bank, Bank of America (BAC), reports third-quarter earnings.

Wall Street will be watching closely, because the results could help clear up the very murky outlook for the financial industry. Institutions like BofA are dealing with the fallout from a declining housing sector, rising defaults on mortgages and other consumer debt, and disruptions to the nation's credit markets.

Predictions Vary Widely

The analysts who cover BofA seem very uncertain of what to expect. According to Reuters Estimates (RTRSY), analysts' estimates for third-quarter earnings per share range all the way from 85¢ to $1.26. The average is $1.06 per share, vs. $1.22 a year ago. Revenue estimates range from $16.4 billion to $19.1 billion, with an average of $18.06 billion, vs. $18.7 billion a year ago.

Bank of America, with 5,800 branches in 29 states, is arguably the U.S.'s only true nationwide bank. It's part of the "big three" of U.S. banks that also includes Citigroup (C), which announced earnings Oct. 15, and JPMorgan Chase (JPM), which announces earnings Oct. 17.

Company Ticker Price (10/16/07) % Chg.
Citigroup C 44.79 -3.14%
JPMorgan Chase JPM 45.11 -2.51%
Bank of America BAC 50.20 -2.37%

Avoiding the Subprime Hit

Citigroup, the nation's largest bank by assets, announced weak results mostly because of those credit market disruptions and because of the bank's exposure to mortgage-backed debt. Credit issues caused a $6.4 billion hit to quarterly profits, which fell 57% from a year ago. In response, the stock fell 3.4% in one day.

"Bank of America has quite a different business," says Morningstar (MORN) analyst Jaime Peters. The company, though it runs an investment bank, focuses far more on "everyday banking" rather than the buying and trading of mortgage-backed debt that hurt Citigroup. "We don't expect Bank of America to have as large a problem as Citigroup did," she says.

Still, BofA faces many of the same challenges as Citigroup.

Paulson Warns of Continued Risk

At the root of the problem are the decline of the U.S. housing sector and the problems many homeowners are having making mortgage payments, often on high-interest subprime loans. Treasury Secretary Henry Paulson highlighted those issues in a speech Tuesday.

"Despite strong economic fundamentals, the housing decline is still unfolding and I view it as the most significant current risk to our economy," Paulson said. "The longer housing prices remain stagnant or fall, the greater the penalty to our economic growth."

Banks all over the country are facing a decline in mortgage origination, losses on loans to housing developers, and a decline in credit quality as more consumers can't meet payments on mortgages or other debt. Measures of credit quality have declined, but they're still better than historic averages, Peters notes.

Although it didn't make the same bets as Citigroup, Bank of America is exposed to the same credit market conditions. That's one reason the bank is participating, along with Citigroup and JPMorgan, in the new so-called "superfund" designed to shore up parts of the credit market. The plan, reportedly arranged but not funded by the federal government, was announced Monday.

Can Core Operations Still Thrive?

The poor Citigroup earnings report prompted D.A. Davidson analyst Jim Bradshaw to lower his estimates for BofA this week. The main uncertainty in the company's numbers will come from the impact of market conditions and credit quality, he wrote.

Still, Bradshaw is optimistic about the long-term trends for Bank of America. Among the possible positive factors: the company's recent $21 billion purchase of Chicago-based LaSalle Bank.

"Despite the disruption in capital markets activity, we believe the core banking operations for the company are beginning to drive very strong results," Bradshaw wrote.

The big question is whether this summer's unexpected credit crunch on Wall Street erodes the success of BofA's huge but run-of-the-mill banking operations on Main Street.

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