Bank Of America Is A Better Buy After Santa's Visit

 |  About: Bank of America Corporation (BAC)
by: David White

Bank of America's biggest problem over the last few years has been its former Countrywide Financial unit. The loans of that unit were often weak when they were written. When the housing market plummeted at the same time as the US economy went into recession, the Countrywide unit turned into a disaster for the Bank of America (NYSE:BAC). With the Fed supporting the housing market over the last several years, the housing market has begun to make a comeback. Santa brought good news on that front.

The November 2012 Existing Home Sales were 5.04 million. This was a great improvement over the previous month's 4.76 million Existing Home Sales. Home prices for November 2012 were up 10.1% year over year. This factor alone makes virtually all of BAC's outstanding mortgage loans better risks (more valuable). When approximately 3.3% of BAC's mortgages haven't brought in payments for 6+ months, the above is hugely positive news. On top of all of this the Fed announced QE4 -- a plan to buy $45B per month of long term Treasuries for an indefinite length of time.

Admittedly, it may not be as effective at keeping down mortgage rates as Operation Twist was; but it will help. Further, the Fed has QE3 (QE Infinity) -- buying $40B per month of MBS -- in place indefinitely. All the above should mean that BAC will recover from its home loan problems in the near future. It has made considerable progress already. If the Fed is smart it will blend intermediate Treasury purchases with its long term purchases. If it does this, it will then be able to use the intermediate term purchases to implement a second Operation Twist. In other words, it would get more bang for its buck as the second Operation Twist would not be "printing money". Plus, foreign governments would be happier that the US was not printing as much money. This would tend to cut down on future inflation.

Not only did Bank of America receive presents for Christmas, but the entire financial industry is supposed to perform tremendously well in Q4 and beyond. Since the end of Q3 2012, the projected earnings growth for Q4 2012 for the Financials sector of the S&P500 has fallen from +27.8% to +16.5% (as of December 21, 2012). This appears unfortunate, but it is still good growth. When you dig a little deeper you find out that the insurance sector is the big drag on the financial sector's growth. If you leave out the negative growth of the insurance industry of the S&P500, the Financials sector had projected growth of +42.10% as of September 28, 2012 (Q3 end).

As of December 21, 2012 the S&P500 Financials sector growth excluding the Insurance industry is projected to be +42.9%. This is slightly higher than the Q3E forecast. Even if the Financials forecast disappoints a bit, the S&P500's Financials sector should still have a great Q4 2012 EPS growth. In BAC's case, it should not only have a great Q4 2012, the average analysts' forecast for EPS growth for FY2013 is 128.60%. This is tremendous. It indicates fantastic improvement in BAC's circumstances.

Just how much have BAC's circumstances improved? In 2009E BAC's long term debt was $523B. At the end of Q3 2012 BAC's long term debt was only about half as much at $287B. During the same period BAC's tangible book value improved from $11.32 to $13.48. Its total deposits increased from $992B to $1,063B. Its allowance for bad loans and leases decreased from $48B to $26B, reflecting a large increase in the quality of its loan and lease assets. Its tangible common equity ratio increased from 5.03% to 6.95%. The following chart of its mortgage production in 2012 shows just how dramatic this turn around has been.

Of course, some of this improvement is only a reflection of new refinancing loans. With US mortgage rates about as low as they are likely to ever go, it is likely that loan production from refinancing may drop off in 2013. Still, the overall uptrend is undeniable. Even if it goes flat for a while, BAC will still make good profits. BAC is also growing in commercial loans. Further, the chart below indicates that BAC has been shrinking its outstanding US credit card debt.

Theoretically, this might be considered bad, but in reality BAC has to a large degree been getting rid of bad or risky credit card debt. This should position it well for what may be a tough 2013 for the US economy.

A chart of BAC's Q3 revenues performance throughout the company is below. It shows great growth in the Global Markets segment from $1.6B in Q3 2011 to $3.7B in Q3 2012. Card Services revenues were down substantially, but many expect this segment's revenues are at or near a bottom. It will eventually start a new uptrend. This will give BAC one more area of long term growth to add to its already good results.

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The US is already too close to the fiscal cliff to avoid a serious slowing of the US economy. Most large businesses have already reined in their CAPEX spending for 2013. They will not change direction on this easily. A deal on the fiscal cliff between now and January 1, 2013 seems remote. The CBO has predicted a recession for the US in 2013 if the US goes over the fiscal cliff. The CBO expects US economic growth to contract by about -2.9% in the first half of 2013 if there is no fiscal cliff deal. The CBO predicts a return to 9.1% unemployment.

The forecasts from the National Association of Manufacturers are far more dire. It forecasts an economic loss of -12.8% of the possible growth from 2012 to 2015. It thinks 2014 could be the peak job loss year with unemployment reaching 12% in 2014. It thinks the total job losses could reach -5.7 million relative to the baseline. It predicts real personal income will drop by almost 10% by 2015.

The US Congress has not been acting with the best interests of the US citizenry in mind. Perhaps this is also the fault of the US citizenry who remain remarkably ignorant of the important factors in the US fiscal budget debacle. Politicians often vote based on popularity of issues in polls. If the US citizenry does not truly understand the issues, the polls reflect that the citizenry can be easily swayed by political rhetoric. This gives the politicians even more reason to act in their own political interests instead of the citizenry's interests. The US citizenry needs to wake up.

In sum, BAC is looking much stronger today than three years ago. The following two charts of Tier 1 Common Capital show this as well as anything.

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Growing Tier 1 Common Capital is always a good sign. Implementing expense saving initiatives is also a positive. BAC has three major such programs. It expects to eventually save about $5B annually from its Phase 1 initiative. It plans to save another $3B annually from an initiative directed primarily at it Wealth Management Businesses. Lastly, it plans to clean up its Legacy Assets and Servicing, which includes a lot of the mortgage related litigation ($1.6B in Q3), etc. This expense amounted to $3.4B in Q3 2012 alone. These plans and results indicate good management. That BAC also maintains ratings of #1 or #2 in many of the banking industry's rating categories speaks well of the company.

BAC at a price/book (mrq) of 0.55 is a big buy, even after its recent rise. It has historically traded at a price/book of just under 2.0. There is a lot of room for stock price appreciation. With the Fed backing the housing industry so strongly, it seems that BAC's success is virtually assured. BAC has earned $0.22 per share in adjusted earnings thus far in 2012. It is forecast to earn $0.42 per share in adjusted earnings for FY2012. It is forecast to earn $0.96 per share in adjusted earnings for FY2013. With the positive housing market news lately, BAC may even do better.

BAC currently pays a dividend of only 0.40%. However, BAC passed the Fed's stress tests with strong results in early 2012. BAC is expected to do even better in 2013 stress tests. Many think this will soon lead to a tripling or quadrupling of BAC's dividend. Stock buyback programs are also being considered. Both of these items would likely add to BAC's stock price. The new stress tests in 2013 may help BAC argue successfully for one or both of the above items. If BAC does not get hit hard by a recession in 2013, one or both of the above mentioned positive actions are likely to be implemented. Even if 2013 is a recession year, BAC should still perform well. It should be set to rise sharply with an eventually housing market recovery. It may be one of the safer stocks to invest in now.

The two year chart of BAC provides some technical direction for a trade.

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The slow stochastic sub chart shows that BAC is currently overbought. The main chart shows that BAC has been in a strong uptrend since mid-summer 2012. The one year analysts' average price target is only $10.53 per share. This is above the current price of $11.25 per share. Of course, such targets can always be raised; and BAC's tangible book value is $13.48. The fantastic Financials sector (minus the insurance industry) results expected for Q4 2012 are +42.9% EPS growth. BAC's average analysts' EPS growth forecast for FY2013 is 128.60%. BAC's stock price likely has plenty of room to rise.

Don't forget its price/book (mrq) is just 0.55; and its FPE is an attractive 11.72. BAC is a long term buy. However, the short term technicals tell you it may see a fall in the near term. Plus, the overall market fundamentals are relatively negative; and they may be getting worse. Q4 2012 EPS forecasts for the S&P500 were +9.2% at the end of Q3 2012. They have since been revised down to +2.9%. We may see them fall still further. If the US goes over the fiscal cliff, the EPS and revenues estimates for FY2013 will be cut dramatically. This will virtually ensure a drop in the overall stock market. An investor should keep this in mind.

Starting to average in now is reasonable. However, if the market falls dramatically, BAC with a beta of 1.77 will likely fall dramatically with it. An investor would then be able to pick up BAC stock at a far cheaper price. In a troubled environment such as the markets are seeing now, it pays to be conservative, even with a good stock. BAC has a mean analysts' rating of 2.6 (a high hold). It has a CAPS rating of three stars. If the housing industry continues to improve with the strong backing of the Fed, BAC -- the biggest originator of home loans in the US -- will be the biggest beneficiary. Too many have been ignoring this fact. Santa's presents (see first paragraph in this article) are tremendously important to BAC. Sometimes a low average analysts' rating can be a good thing. It can mean many future ratings increases. These would/will cause the stock to rise.

Note: Some of the fundamental information above is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BAC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.