Why D.E. Shaw decreases position in Bank of America Corp.

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D.E. Shaw and Bank of America Corp.

D.E. Shaw bought new small positions in Crescent Point Energy (CPG), Knowles Corp. (KN), and St. Jude Medical (STJ). Notable position decreases were in Apple (AAPL) and Bank of America (BAC). The fund increased positions in Liberty Global PLC (LBTYK) and Time Warner Cable (TWC).

BAC presentation

D.E. Shaw decreased its position in Bank of America Corp. (BAC) that accounted for 1.11% of the company’s U.S. long portfolio in 4Q13. The position accounts for 0.51% of the 1Q14 portfolio. The fund also trimmed its stake in Citigroup (C) last quarter. George Soros’ Soros Fund Management also sold its stakes in financial services stocks, including banking giants JPMorgan Chase (JPM) and Citigroup (C) in 1Q14.

Why BAC shares fell in April?

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Shares fell in April after BAC reported a suspension of its capital plan over an error in its “stress test” submission to the Federal Reserve. On April 28, BAC announced a downward revision to the company’s previously disclosed regulatory capital amounts and ratios due to an incorrect adjustment related to the treatment of certain structured notes assumed in the Merrill Lynch acquisition in 2009. It added, “The Federal Reserve Board has directed the company to resubmit its data templates and requested capital actions contained in the 2014 Comprehensive Capital Analysis and Review (CCAR). As part of this process, Bank of America will engage a third party to review processes and the materials prior to resubmission.”

The release added that on Federal Reserve Board request, “the company is suspending its previously announced 2014 capital actions, including the $4 billion common stock repurchase authorization and the planned increase in the quarterly common stock dividend from $0.01 per common share to $0.05 per share.”

BAC recently said in a May filing that, “The third party review has been completed and resulted in additional adjustments that had a de minimis effect (less than one basis point reduction) on the Corporation’s reported regulatory capital ratios for the period ended September 30, 2013, and no effect on such ratios for the period ended March 31, 2014.”

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A Wells Fargo analyst noted in April that, “While we do not anticipate the actual net effect on BAC’s capital or EPS will be overly material, we believe the combination of reputational damage, upward pressure on expenses and potentially more conservative capital return request in 2015 will cloud BAC’s share price performance for the next few months.”

Results beat expectations, but litigation expenses impact bottom line

BAC’s first quarter results beat expectations despite a net loss of $276 million, or $0.05 per diluted share, for 1Q14, compared to net income of $1.5 billion, or $0.10 per diluted share, in the same period last year. The results included $6 billion in litigation expense related to the previously announced settlement with the Federal Housing Finance Agency (or FHFA), and additional reserves primarily for previously disclosed legacy mortgage-related matters. Bank of America reached a settlement with Financial Guaranty Insurance Co. (or FGIC), as well as separate settlements with The Bank of New York Mellon, as trustee, for certain second-lien residential mortgage-backed securities (or RMBS) trusts for which FGIC provided financial guarantee insurance. Revenue declined 3% from 1Q13 to $22.8 billion. BAC said excluding litigation and retirement-eligible incentive compensation costs from both periods, its non-interest expense declined $1.2 billion from the same quarter last year.

Low interest rates remain a headwind

Net interest income fell 5% from the same quarter last year to $10.3 billion driven by lower yields on debt securities due to an approximate $540 million swing in market-related premium amortization expense.

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According to data from Keefe, Bruyette & Woods, and SNL Financial, which was cited by Financial Times, the average net interest margin for Wells Fargo (WFC), Bank of America (BAC), JPMorgan Chase (JPM), and Citi (C) declined to 2.64% in the first quarter—the lowest level in at least a decade. The report added that low interest rates have “squeezed returns from loans and investments across the industry.”

Noninterest income was flat compared to the same quarter last year due to lower mortgage banking income and lower trading account profits. This was largely offset by year-over-year (or YoY) increases in investment and brokerage income, equity investment income, and gains on the sale of debt securities.

On the business environment, BAC noted in its first quarter filing that, “In the U.S., economic growth slowed significantly in the first quarter of 2014 following healthy growth in the second half of 2013. With financial markets impacted by Russian-Ukrainian tensions, U.S. Treasury yields declined modestly over the quarter, while equity markets were essentially flat. During the first quarter of 2014, the Federal Reserve reduced, as previously announced, its securities purchases, bringing targeted monthly purchases to $55 billion in April. The Federal Reserve also indicated that it was likely to continue to reduce the pace of its purchases.”

Jefferies analyst Ken Usdin was bullish on BAC and said on the first quarter earnings in April that the “BAC story should get cleaner as the revenue outlook improves and legacy mortgage and litigation burdens further subside following aggressive actions in 1Q. We continue to like BAC due to a visible path to improved profitability, step-up potential for normalized earnings, and better capital return over time.”

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