Bank of America returns to profitability

A quarter after losing $1.8 billion, banking giant reports profit of $4.2 billion, topping Wall Street estimates; but stock falls on warning of weak credit quality.

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By David Ellis, CNNMoney.com staff writer

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Bank of America chief Ken Lewis
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Bank of America shares have staged a recovery in recent weeks, only to see some of those gains erased during Monday's session.
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NEW YORK (CNNMoney.com) -- Bank of America surprised Wall Street Monday with a much bigger-than-expected first quarter profit of $4.2 billion, even as the company was stung by rising credit costs.

On a per share basis, the company said it earned 44 cents during the quarter. A year ago, the bank reported a profit of $1.21 billion, or 23 cents a share.

The results were much better than analysts' expectations of a profit of $615 million, or 4 cents a share, according to Thomson Reuters.

But investors were worried by CEO Ken Lewis' warnings about "deteriorating credit quality," particularly within the company's consumer-related and commercial loan portfolios. Shares of Bank of America (BAC, Fortune 500) tumbled 15% in midday trading.

"Make no doubt about it - credit is bad and we believe credit will get worse before it will eventually stabilize and improve," Lewis told investors during a conference call Monday morning.

The company did manage to generate robust results from its two major, albeit controversial, purchases from last year - Merrill Lynch and Countrywide Financial.

Countrywide, the California-based mortgage lender, helped Bank of America capitalize on the latest surge in mortgage lending and refinancing activity, the company said.

The bank added that the addition of Merrill Lynch's operations this quarter helped strengthen results across a number of divisions, including Bank of America's wealth management and trading units.

But BofA's results were also lifted by gains that are unlikely to be repeated. Adjustments on some of Merrill Lynch's debt also helped Bank of America book a gain of $2.2 billion in net interest income during the quarter.

At the same time, the company recorded a $1.9 billion pre-tax gain on the sale of part of its stake in China Construction Bank. Bank of America said it continued to own roughly 17% of the Chinese lender's common shares.

"There is no question about it that those are one-time profit enhancements," said David Dietze, chief investment strategist of New Jersey-based Point View Financial Services, which owns Bank of America stock.

But growing credit problems at the bank, specifically the firm's consumer-related loan portfolios, continued to remain in focus as more and more Americans found themselves out of work, cutting back on spending or filing for bankruptcy.

Bank of America's credit card division, for example, swung to a net loss of $1.8 billion during the quarter, hurt by rising credit costs. The bank also added $6.4 billion to its loan loss reserves in the quarter.

Lewis declined to hazard a guess as to when loan deterioration would subside, but said the firm was anticipating that the rate of unemployment would not peak until sometime next year, most likely not reaching double digit levels.

The company, however, maintained that it continued to extend credit during the first three months of the year. Many banks have been criticized for not using the billions of dollars in government assistance they've received for new loans.

During the quarter, Bank of America said it funded $85 billion in first mortgages, although 75% of that amount was for refinancing as opposed to home purchases.

When questioned about the bank's capital levels, or ability to absorb future losses, Lewis said he did not believe that the bank needed additional capital. But he added that the decision was not up to him.

Government regulators are poised to announce the results of stress tests of the nation's 19 largest banks as early as this week. The tests, which were launched in March, are geared towards determining which banks may need additional capital.

As of quarter end, Bank of America's Tier 1 capital ratio stood at 10.1%. A bank with a reading of 8% or higher is generally considered well capitalized.

Tangible common equity, another measure of financial strength that the markets appear to be paying attention to lately, stood at 3.1%, the company said. Typically, investors view banks with a TCE below 3% to be not adequately positioned to absorb big losses.

Bank of America is the latest big bank to report surprisingly strong numbers this quarter.

Over the past two weeks, rivals Wells Fargo (WFC, Fortune 500), JPMorgan Chase (JPM, Fortune 500) and even Citigroup (C, Fortune 500), which like Bank of America has received $45 billion in government assistance, have all delivered earnings that exceeded Wall Street's expectations. To top of page

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