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Summary

  • Bank of America's capital overstatement is less a substantive issue and more a controls issue.
  • The capital overstatement itself was very small and likely meaningless.
  • The larger point is investor trust and BAC must earn it back.

Well that was ugly. The unexpected news of Bank of America (NYSE:BAC) having to suspend its buyback and dividend increase yesterday sent the stock plummeting $1, wiping out $10 billion of shareholder value in a matter of hours. I am a long time BAC bull, as you know if you've read my articles over the past year and a half, and I still think the story is intact for BAC. If we strip away the emotion and disappointment of yesterday's announcement, there is a terrific franchise underneath. However, this black eye should not be ignored.

We are all well aware of the issue BAC reported yesterday so I won't rehash the press release; you can read it linked above if you haven't done so already. What I will say is that the actual issue at hand, BAC overstating its capital due to an accounting miscalculation, is a larger hypothetical issue than it is substantively. Depending on the metric used BAC's capital ratio was overstated by a few basis points by the miscalculation. Whether BAC's Tier 1 capital is 11.8% or 11.9% is really immaterial as that is far in excess of "well capitalized"; what's at issue is that investors can lose trust in a company's management when things like this happen.

We all know BAC has rapidly improved its financial condition over the past couple of years and its capital numbers demonstrate that. Thus, the fact that the number was overstated really doesn't matter as we aren't talking about huge numbers; what matters is that investors and the Fed could now make a point that BAC's numbers cannot be trusted. For management's and shareholders' sakes, I really, truly, sincerely hope the revised numbers are correct because if there is another revision later this year, we could see BAC at $10 simply based on a lack of trust. While this isn't a standard accounting irregularity, it's pretty close and any kind of irregularity is ugly for shareholders, as we saw yesterday. I believe management would have made 100% sure the revised numbers are correct because no one will tolerate another one of these press releases. If we get another press release like this anytime soon, someone very important at BAC will likely be shown the door.

I honestly think the revisions were so small that this issue will pass and people will eventually move on. Yes it is difficult to handle right now because it seems so huge but since it wasn't a material overstatement, I think it will be largely forgotten in a few months. Assuming no other surprises pop up, BAC should be in good shape and $15 will prove to be a prescient point at which to buy. Of course, there are those who disagree and for a well reasoned bear view on BAC, look no further than Regarded Solutions, who has been on the other side of this trade for as long as I can remember. Good points are made in his piece from yesterday and as a bull, it was an interesting read that I recommend.

With the revisions being so small and with the bank still far exceeding the well capitalized hurdle, I think the end result of this will be a dividend increase and buyback reinstatement. BAC did the right thing in notifying its regulator and suspending capital returns under the circumstances but in reviewing the revised numbers, I believe the Fed will allow it to resume its capital return activities. In fact, I don't think it will even take that long, perhaps a month or two, before all is back to normal and this unpleasantness is behind us. If, for some reason, the Fed makes an example of BAC, ala Citigroup (NYSE:C), we could see this stock down in the $12 area again. I really hope that doesn't happen but if it does, the chance to buy BAC under tangible book value again would be too good to pass up. I don't think it will get that bad but don't expect a quick rebound to $17 either.

Disclosure: I am long BAC. 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.

Source: Bank Of America: Can Management Still Be Trusted?