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Summary

  • Bank of America’s stock has been eviscerated over the past month.
  • Recent developments have occurred that may remedy the bank's woes in short order.
  • This has created a major buying opportunity in the stock.

Bank of America (NYSE:BAC) shareholders can't catch a break. The bank handily beat earnings and the Fed's stress test. Nonetheless, the stock has been hamstrung by a series of negative headlines in recent weeks and is down nearly 20%. Even so, it seems there may be light at the end of the tunnel, so to speak. In the following sections I will lay out my bull case for the stock going forward.

(click to enlarge)

(Chart provided by Finviz.com)

Bank of America's stock has been eviscerated over the past month

Bank of America's shareholders have been excessively punished in recent weeks based on a series of negative headlines. First, the bank had to suspend the capital return plan which included a $4 billion buyback this year as well as a boost in the dividend due to an account error related to structured debt the bank inherited from the Merrill Lynch acquisition. Second, there is news the DOJ was looking for a $13 billion settlement regarding past mortgage issues related to the 2008 housing debacle. Finally, JPMorgan (NYSE:JPM) just came out and stated in a regulatory filing late Friday the bank expects markets revenue, which includes fixed-income and equities trading, to decline 20% in the second quarter. This has put the entire banking sector under pressure. Even so, certain recent developments lead me to believe the drop in the stock is actually a buying opportunity.

Recent developments regarding these issues have occurred that bode well for Bank of America's future

In the following section I will address the current issues and detail the positives of each one.

The Merrill Lynch Accounting Blunder

When Bank of America announced the bank had to pull the capital return plan approved by the Fed due to an accounting error, it seemed like the bank was in big trouble. Yet, I submit this couldn't be further from the truth. First, let me say that no one is perfect. We all make mistakes from time to time. I do not feel the accounting error is an indication the bank has weak internal controls. It was a one-off issue.

Further, the error had no effect on GAAP earnings or the bank's net worth and bank of America is in the process of resubmitting the plan in the near future. Lastly and most importantly, Warren Buffett announced Monday morning on CNBC that his $5 billion in preferred shares were reclassified from accumulative to non-accumulative effectively resolving the bank's regulatory capital issue. This was huge news that seems to have slipped under the radar. When asked about Bank of America's recent woes and future Buffett stated:

"That error that they made doesn't bother me. It doesn't change my feeling about Bank of America's risk management one iota."

Back when Buffett bought the preferred stock at $7, many believed Bank of America was teetering on the edge of bankruptcy. Buffett was right then and I posit he is right now.

Potential $13 Billion DOJ Settlement

This issue is primarily related to Bank of America's acquisition of Country Wide mortgage. I surmise the bank is most likely settle with the DOJ. This should close the book on the legal woes derived from the 2008 housing debacle. The major positive for the bank is the fact the bank's legal liabilities going forward should be substantially less. The legal overhang holding the stock back should dissipate.

JPMorgan's Second Quarter Warning

In a regulatory filing late Friday the bank expects markets revenue to decline 20% in the second quarter. This has put the entire sector under pressure. Nonetheless, I see this as a JPMorgan specific issue. Remember, JPMorgan missed earnings while Bank of America beat estimates. I see the indiscriminate selloff of the banks based on bad news from JPM as a bulling opportunity. When a stock sells off in sympathy with its sector, hopefully you have dry powder and can take advantage.

This has created a major buying opportunity in the stock

Several key specifics demonstrate the bank's continued business momentum has been overlooked as the negative headlines continue to hit. Total period-end deposit balances were up $38 billion year-over-year to a record $1.13 trillion. The bank funded $10.8 billion in residential home loans and home equity loans in the quarter. More than 1 million new credit cards were issued in the quarter. Global wealth and investment management reported record asset management fees of $1.9 billion, a pretax margin of 25.6 percent. Global banking average loan balances were up 11 percent year-over-year to $271 billion. Credit quality continued to improve with net charge-offs down 45 percent year-over-year.

The bank is making great strides where it really counts. Furthermore, Bank of America has the highest projected EPS growth rates of all five major banks currently.

(click to enlarge)

(Table provided by Finviz.com)

Bank of America's EPS is expected to grow by 62% next year and 19% over the next five years. EPS share growth is probably the most important factor to consider when estimating the fair value of a stock. I posit this sell off may mark the low point for the stock this year.

Downside risks

Macroeconomic and geopolitical headwinds emerge

If something goes awry in China, Europe or the Middle East the markets will be negatively affected. No stock will be immune. The current "wall of worry" seems to be growing taller. This concern is amplified by the fact the market is still near all-time highs. This is a potent combination.

Legal risks still remain

Bank of America has not yet put the entirety of the company's legal risks behind it. Legal challenges from investors in mortgages and mortgage backed securities could still prevail against the bank.

The housing market craters

With rates on the rise, the housing market could take a hit. The housing recovery is still in its infancy. It remains to be seen if the housing market can withstand higher mortgage rates.

Conclusion

The proverb it is always darkest before the dawn comes to mind when considering the Bank of America current status. I submit the bank is on the right track. Nonetheless, based on a series of negative headlines the stock has been sold off wholesale. You have to buy low to sell high. With a PEG ratio of .84, a forward P/E ratio of 9.77 and a price to book ratio of .73, the bank appears undervalued on a historical and relative basis.

(Table provided by Yahoo.com)

The Bottom Line

The current negative headlines regarding Bank of America are related to the past, not the future. Remember, nothing is ever as good or as bad as it seems. The risk appears well worth the reward at this point. The time to buy is when others are selling. My twelve month price target for the stock is $20 based on current fundamentals and forward guidance.

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.

Source: Bank Of America: Always Darkest Before The Dawn