Bank Of America: The Good, The Bad And The Future

| About: Bank of (BAC)

Five years removed from the financial crisis that rocked the banking industry, 2013 appears to bring with it a fair amount of opportunity.

Though challenges still remain for the beleaguered sector -- including the implementation of harsher regulations stemming from said financial collapse -- optimism abounds for analysts and shareholders of companies like Wells Fargo (NYSE:WFC), JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C). One can see this enthusiasm simply by looking at the performance of the NASDAQBank Index, which is up 11 percent in the past six months.

One financial services company in which the outlook still leans toward cautiousness is Bank of America Corp. (NYSE:BAC). In 2010, the banking giant was on the verge of bankruptcy after recording a $2 billion loss for the year. It returned to profitability in 2011 with $1.4 billion in net income, followed by $4.2 billion in 2012.

The company's stock price hit a low of $3.95 a share in February of 2009, but has rebounded and it is currently selling close to $12 a share.

Depending on your viewpoint, Bank of America is either a stock on the rise as the company's fortunes brighten, or a risky investment given economic, regulatory and internal challenges.

The Bad

The year got off to a bad start with the announcement that the U.S. economy actually contracted in the fourth quarter of 2012, when it was anticipated to grow 1%. On top of that, consumer confidence fell in January to its lowest level since 2011, indicating that after a fairly confident 2012, consumers aren't feeling like spending in 2013--at least not yet.

Low consumer confidence has the potential to negatively impact the entire banking sector. Banks are still trying to improve the quality of their loan portfolios, which have suffered since the 2008-2009 financial crisis. For this to happen, consumers need to spend, which will boost employment and real estate values. Consumers won't spend if they are afraid to do so.

Banks also face the potential for depressed profit margins. One cause is the ongoing low interest rate environment, which places a cap on how much banks can earn from interest income. In addition, banks are continuing to compete heavily for business from affluent customers. The Deloitte Center for Financial Services 2013 Banking Industry Outlook says as the industry deepens its focus on that finite customer base, the competition for those dollars will depress margins.

Perhaps the greatest industry challenge is the aftermath of the financial crisis spurring the creation of the most comprehensive set of new regulations in the last 70 years, many of which will be implemented in 2013.

In addition to these barriers, Bank of America faces additional ones internally. Perhaps its greatest impediment to growth is its continuing struggles; the company continues to struggle with customer service issues. For the past two years, Bank of America has scored the lowest among its peers on two different surveys -- the American Customer Satisfaction Index and the MSN Money Online Survey -- that measure customer sentiment. In fact, on the MSN survey, which asks customers about service at 150 companies across various industries, B of A garnered the largest percentage of "poor" responses from survey participants.

The Good

Shortly after the announcement of a contracting fourth-quarter economy, the news took a slight turn for the better when it was announced that the economy created 157,000 jobs in January, and that overall 2012 job creation was revised upward. So things might be looking up.

If they are, bright spots for the banking industry may emerge. According to Deloitte, an improving economy would provide potential revenue growth in the corporate and institutional markets. If the real estate market continues to improve, growth in residential mortgage lending should follow.

The company reduced its long-term debt by $100 million last year. This means less money spent on interest expense, which will boost profits. All told, B of A aims to slash $5 billion in costs by the end of this year.

In addition, it is managing its risk better, as credit losses declined 25 percent from fourth quarter 2011 to 2012.

The company also looks to remake its image and build a more loyal customer base. CEO Brian Moynihan recently wrote a letter to employees outlining the emphasis he is putting on a new customer-friendly approach. The bank also plans to launch a new customer focused ad campaign in April and has hired a new public relations firm.

Overvalued, Undervalued or Priced Correctly?

Many investors may look at the company's current price-to-earnings ratio, which is the ratio of its stock price relative to its earnings, and determine the stock is currently overvalued. A higher P/E ratio means investors expect higher earnings down the road and have already priced those increases into the stock price. A low P/E means the opposite. Low P/E ratios also indicate a stock is a better buy than a similar company with a higher P/E ratio.

Based on its closing price the day it announced its 2012 earnings of $0.25 a share, Bank of America's P/E ratio was about 45. That's rather expensive compared with its peers: JPMorgan Chase (8.75), Citigroup (16.97), Wells Fargo (10.43) and U.S. Bancorp (11.54). However, Bank of America's earnings were negatively impacted by more than $5 billion in one-time fees. Without those expenses, B of A would have booked $0.55 a share, for a more reasonable P/E ratio of 20.5.

Looking forward, analysts estimate the bank's 2013 earnings per share to be $0.97. That would give it a forward P/E ratio of about 11, on par with the other big banks.

More News -- Coming Soon

On March 7, the Federal Reserve will release its 2013 stress-test results, which grade banks on how they would fare in the event of another financial crisis. Bank of America is expected to pass, but investors will punish the stock if it does not.

A week later, the Fed will release results of its review of bank capital plans. If the Fed deems that Bank of America is adequately capitalized, it could increase its quarterly dividend. A request in 2011 to raise its dividend was denied.

According to John Maxfield of The Motley Fool, Bank of America has more than $10 billion in accumulated capital above regulatory minimum requirements. With that excess, he wrote, the company could distribute $1 per share in dividends, but he anticipates an increase in the payout from its current $.01 per share to $.04.

Given the relative uncertainty, it's not surprising that most of the company's 20-something analysts rate the stock as a hold. It's a somewhat risky time to buy because of the stock's recent price appreciation combined with the chances -- however slim -- that the company will receive bad news from the economy, the Federal Reserve and/or its customers.

In addition, the two aforementioned announcements coming in March are already expected to be favorable for the bank. Therefore, any stock price increase resulting from a positive outcome has already been factored in. However, if either of the two announcements go against B of A, the company's stock will likely take a sizable hit.

And though Bank of America has good intentions to improve customer service, that's all they are right now -- intentions. The financial giant has a long way to go to rebuild its reputation and give customers a reason to stick around and not vent their frustrations on surveys and message boards. Many companies have discovered that the goals of cost cutting and enhancing customer service are often at odds.

At the same time, most analysts would instruct current shareholders not to sell. Those with optimism see a company using its solid balance sheet as a foundation to strengthening its business and giving its shareholders maximum value. While it continues to be held back by mistakes of the past, those legacy issues will eventually be resolved if current trends continue. Therefore, many see Bank of America re-asserting itself as an industry leader.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.

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