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Bank of America's Q2 Earnings Reflect an Important Milestone

Bank of America (NYSE: BAC) reported second-quarter earnings today that, despite the drop in its stock price following the news, prove again that the nation's second-biggest bank by assets has long since turned the corner on the financial crisis.

It earned $4.9 billion in the quarter, which was 11% higher than its earnings in the same period last year. The growth in Bank of America's earnings per share was even better. It earned $0.46 per share, up 12% compared to the year-ago quarter and comfortably above the consensus estimate of $0.43 per share.

The Bank of America Plaza in Dallas, Texas. Image source: Getty Images.

Multiple factors played into Bank of America's performance last quarter, but one is particularly notable. The bank's efficiency ratio, which measures the percent of revenue consumed by operating expenses, came in at 60%. This is one of the bank's principal performance targets; it's also a standard threshold in the industry demarcating between banks that are considered to be savvy operators and those that aren't.

Chairman and CEO Brian Moynihan was effusive in his praise for the bank's second-quarter results:

Against modest economic growth of 2%, we had one of the strongest quarters in our history. All of our businesses delivered strong results, with several setting new records. The investments we made to transform how we serve clients produced 500 basis points of operating leverage in the quarter. We achieved our 60 percent efficiency ratio target, and we continued to manage credit risk carefully in line with responsible growth. This supports our plan to return $17 billion in capital during the next four quarters, including a 60% increase in the quarterly common dividend.

The second quarter marked another turning point in Bank of America's efforts to fully and finally put the financial crisis behind it. Most importantly, it was the quarter in which the North Carolina-based bank was given the go-ahead from regulators to dramatically boost its dividend and stock buybacks.

The purpose of the stress tests is to determine whether banks with more than $50 billion in assets on their balance sheet have enough capital to survive a sharp economic downturn in which the unemployment rate soars to 10%, asset prices plummet, and the economy enters into a deep recession. So long as they do, and assuming that their capital planning process is found by the Federal Reserve to be sufficiently sophisticated, then banks are free to increase the amount of capital that they return to shareholders.

Brian Moynihan, Bank of America's chairman and CEO. Image source: Bank of America.

In Bank of America's case, there was little doubt that it would pass this year's test. It entered the exercise with a common equity tier 1 capital ratio (CET1 ratio) of 12.1%, translating into $169 billion worth of high quality, highly liquid capital. This gave Bank of America a roughly $100 billion cushion over the amount that would be needed to meet the regulatory minimum CET1 ratio of 4.5%. Thus, even though it was projected to lose $26.4 billion through the test's nine-quarter horizon, the bank still emerged with more than enough loss-absorbing capital to appease regulators.

Immediately following the release of this year's stress test results, Bank of America announced that it would increase its quarterly dividend by 60%, from $0.075 per share up to $0.12 per share. The bank also added $12 billion to its share buyback authority, up from $5 billion last year.

Bank of America's buybacks are especially noteworthy. First, because they are one of the main levers it can pull on at this point to juice shareholder returns, as the bank's size shuts it out of the market for mergers and acquisitions. And second, because reducing the bank's share count has been a goal of Moynihan's since taking the reins at Bank of America seven years ago.

For its shareholders, in turn, there is every reason to be pleased with Bank of America's performance in the second quarter. Higher interest rates, lower taxes, and fewer regulations will further catalyze its progress, but, for the time being, the bank is right where it needs to be.

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John Maxfield owns shares of Bank of America. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.