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Can Bank of America Ever Crawl Out of the Muck?

  +Follow September 17, 2013 8:35AM
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If an investor somehow had forgotten about the existence of the 2008 financial crisis, Bank of America Corporation’s (BAC) stock underperformance would look completely confounding. The country’s second largest bank rang in $2.1 billion in profit last quarter and has been consistently been outperforming expectations, the stock trades for under $15 a share and has risen less on the year than the S&P 500.

Of course, investors remember the crisis all too well, and many feel that despite the bank’s sizable profits the bank isn’t out of the muck yet. Even six years later, the bank could still be facing billions more in losses stemming from settlements and lawsuits associated with the Great Recession.

 Could be, though, are the operative words. Those lawsuits, BOA bulls argue, might never materialize, at least on that catastrophic scale. The fact is that the company, right now, is insanely profitable, and billions in profits are billions in profits the market can’t ignore forever.

This disconnect between the banks’ bulls and bears are probably why BOA is, by volume, far and away the most popular stock on the entire market, trading over a hundred million shares a day. The next nearest volume leader, Facebook Inc. (FB) only trades around 60 million.

So what are the cases for and against Bank of America as an investment opportunity?

 

Bank of America: the Bull’s Case

Countrywide is still Bad, But it’s Getting Better

The purchase of toxic assets form Countrywide had cost Bank of America’s investors some $50 billion, which had hobbled the company for years. The company, however, is writing down those ongoing losses at a dissipating rate. According to KBW analysts, those bad asset writedowns will fall to $2 billion a quarter by the end of 2013, $1 billion a quarter in 2014 and $500 million in 2015.

At its peak, Countrywide assets were costing Bank of America over $3 billion a quarter.

 

There Will Be No Financial Crisis 2.0 for a Leaner, Meaner BOA

On Sept 16 Bank of America passed its mid cycle stress test, shoeing they had more than enough capital to withstand a major economic downturn. The bank is far less leveraged than they once were, and proved to regulators that should the US experience another economic meltdown they have enough unleveraged assets to recompense investors.

The bank has also become leaner as of late, looking to possibly completely fold Merrill Lynchinto their operations, and cut $8 billion in expenses by year’s end.

 

The Bank is Quite Undervalued

Bank of America still rings in a ton of revenue, yet it trades for far below book. This is mainly due to the fact that investors are uncertain what the ultimate cost of the Countrywide unit to Bank of America will be. Looking at the price-to-book value, the bank is the most undervalued major in America, and is trading for at least 10 percent under what it should be valued right now, let alone what it will be once the Countrywide debacle begins to shrink up at an exponential rate.

 

Bank of America: the Bear’s Case

Uncle Sam's A-Coming

A lot of sunny speculation concerning Bank of America is born from an assumption that its problems associated with the financial crisis will become less of a problem in the future. But there’s a lot of indications that there’s still plenty of crippling legal woes still to come for the bank

On Aug. 7 the Department of Justice accused Bank of America of having pumped billions in toxic assets to investors that the bank knew to be bad. Concurrent with the DOJ accusations the Securities and Exchange Commission charged the bank with committing mortgage securities fraud in connection with those same bad loans.

 

An $8.5 Billion Settlement that is “Pennies on the Dollar”

In 2011 Bank of America settled with various investors to the tune of $8.5 billion over the bad assets the bank unloaded in the midst of the financial crisis. While that would seem to be a significant payout, some affected parties like American Insurance Group ($AIG) challenge this number, claiming the payout is still a fraction of what the bank truly owes.  

AIG claims the parties that accepted the settlement – like Goldman Sachs Group (GS) and BlackRock (BLK) were not nearly as negatively affected, and the bondholder trustee Bank of New York Mellon ($BK) had a conflict of interest that should not have allowed it to sign off on the settlement

If the challenge of the original settlement is successful, Bank of America could be opened to lawsuits of a magnitude several times worse, with parties like AIG seeking to recover up to $108 billion in losses. In essence, the company could be litigated out of existence.

 

The Experts Just Don’t Like Them

For these reasons, analysts are way down on Bank of America, with two-thirds of analysts putting a "hold"  rating on the stock, wiht two going as far as to slap a "sell" designation on the bank. In the most recent analyst rating, on June 7 Macquarie put a price target of just $12 on the stock, calling for an underperform.

While the consensus of the stock is just over $15 a share, the majority view of the stock is that it will stagnate, or worse.

 

Bank of America is currently at $14.53 a share, up 20.79 percent on the year.

 

(image of Bank of America in Washington D.C. courtesy of WIkipedia Commons)

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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