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Bank of America (NYSE:BAC) bulls have a lot of thinking to do. On one hand, the very low P/BV makes the stock look comparatively cheap to virtually all of its peers. Even after its recent run-up. But, is the 0.6635 P/BV real?

BAC Price / Book Value Chart
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BAC Price / Book Value data by YCharts

With earnings around the corner, the stock has started to top out as investors wait for the all important quarterly report. Bank of America has been settling its legal issues, cutting costs, still has a large capacity for new loans, and has been slowly improving its capital position. But, the recent rise in interest rates has a few implications that threaten its investor's undervalued thesis. When rates rise as fast as they have, Bank of America (and other banks) is going to have to make an accounting adjustment that will lower the bank's assets and in-turn equity values. With an equity adjustment done in this manner, a lower denominator coupled with the bank's higher price will immediately move up the P/BV.

The actual affect is hard to determine but, according to CFO Bruce Thompson, "it could take three years to make enough net interest income to replace lost capital."

10 Year Treasury Rate Chart
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10 Year Treasury Rate data by YCharts

With lost capital, the bank's going to have less capacity for loans, a higher P/BV but, this is a slightly mixed bag because the write-off doesn't affect net incomes. Higher revenues from the increasing rates (with the lower equity) are going to bring up the ROE of virtually every bank, every bank able to "capitalize" on the higher rates that is. But then again, even flat earnings will bring up the ROE of banks with adjusted equity accounts.

All said, this is going to be a very transitional period so I would expect a bumpy ride. And, I have a hard time thinking BAC is going to make it out of this better than Wells Fargo (NYSE:WFC) and JPMorgan (NYSE:JPM) when their already high returns start to look astronomical (as they already do) compared to BAC's. But then again, a BAC sell-off would make shares look attractive again since it would lower the P/BV (sarcastic). What's better, higher earnings or a lower P/BV? Definitely something to think about. Choose your investments wisely!

Source: Bank Of America Book Bulls To Be Tested