IG Index Spread Betting Market Review

Posted on | April 20, 2009 |

Despite Bank of America’s better-than-expected first-quarter results, Wall Street opened sharply lower this afternoon as investors fear that rising unemployment will lead to a surge in banking sector bad debts.

Bank of America (BofA) today produced first-quarter profits that were more than double of last year’s earnings, helped by strong contributions from Merrill Lynch. The largest US bank by assets reported a net income of $4.24 billion for the first-quarter, up from $1.21 billion a year ago. After taking into consideration the impact of preferred stock dividends, however, net income to common shareholders came in at $2.81 billion, up from a comparable figure of $1.02 billion from the year before.

On a per-share basis, first-quarter earnings came in at 44 cents or 17 cents a share excluding extraordinary items, thus beating Reuters’ consensus expectations of 4 cents a share.

The bank said that Merrill Lynch, which was acquired on January 1 2009, contributed $3.7 billion to net income (excluding certain merger costs), while an increase in mortgage lending and refinancing volumes helped Countrywide Financial, purchased on July 1 2008, add to net income as well. BofA confirmed that both companies were on track to meet targeted costs savings, with Countrywide Financial actually ahead of schedule.

‘The fact that we were able to post a strong, positive net income for the quarter is extremely welcome news in this environment,’ said Kenneth Lewis, chairman and chief executive officer of the bank. ‘It shows the power of our diversified business model as well as the ability of our associates to execute. We are especially gratified that our new teammates at Countrywide and Merrill Lynch had outstanding performance that contributed significantly to our success.’ [1]

So far so good, but the worrying part in all of this is that BofA may not be able to sustain the performance seen in the first quarter because there were some very large one-off contributions; BofA received $1.9 billion from selling its shares in China Construction Bank and benefitted from an additional $2.2 billion gain emanating from declining bond prices.

Also worrying is the rapid deterioration in the bank’s asset quality. BofA today revealed that credit quality had deteriorated further across all divisions as house prices continue to decline on the back of weak economic conditions. ‘Consumers are under significant stress from rising unemployment’ and ‘these conditions led to higher losses in almost all consumer portfolios,’ BofA explained. This was reflected by a surge in BofA’s bad debts, which jumped from $7.8 billion last year to $25.7 billion as a growing number of Americans defaulted on mortgages.

‘I don’t see anything that makes me think all of a sudden people are going to take the pressure off Lewis,’ said Walter Todd, a portfolio manager at Greenwood Capital Associates. ‘The biggest question I have is; what is going on with these non-performing assets?’ [2]

Not surprisingly, BofA’s share price was knocked 10.4% lower to $9.50 this afternoon. Losses soon spread to rival banks as well, with Citigroup plunging 11.5% to $3.24, Wells Fargo tumbling 7.2% to $18.81 and JPMorgan Chase sliding 4.5% to $31.75.

It has been astounding to see the value of some banks more than double over the past month, but today’s reaction seems to suggest that the euphoric state may very well have come to an end. I say this because fundamental problems in the banking sector have not yet been resolved, contrary to what some may be thinking.

Also today, Oracle the world’s largest enterprise software company, has agreed to acquire Sun Microsystems in a $7.4 billion cash deal after negotiations with IBM collapsed. This means that Oracle will be paying $9.5 for each Sun share, a 42% premium to Friday’s close of $6.69.

Oracle President Safra Catz said the acquisition, which the companies expect to close this summer, will add at least 15 cents per share to Oracle’s earnings in the first full-year after closing.

The deal would strengthen Oracle’s position against IBM. Oracle has done a good job on the acquisitions it had done earlier,’ said Robert Jakobsen of Jyske Bank. ‘It makes sense also historically. Oracle has been more successful commercialising software than Sun.’ [3]

Shares in Oracle fell 5.4% to $18.03 following the surprise announcement, while Sun’s share price jumped 36% to $9.10 this afternoon.

By around 3.40pm (London time) the Dow Jones Industrial Average had plunged 212.27 points (-2.61%) to 7919.06, while the broader S&P 500 had declined 25.1 points (-2.9%) to 844.5.

[1] Source: Bank of America website (20 April 2009)
[2] Source: Reuters News (20 April 2009)
[3] Reuters News (20 April 2009)

By Anthony Grech, Research Analyst, IG Index.

The above comments do not constitute investment advice and neither IG Index nor Spread-Betting.org accept any responsibility for any use that may be made of them.

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