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Summary

  • A host of negative news on Bank of America caused the stock to plunge by 15% since March 2014.
  • The bank has sped up the resolution of its legal problems and the management sees the light at the end of tunnel.
  • A stock price turnaround is imminent once investor anxiety regarding litigation issues settles down.

Bank of America (NYSE:BAC) has been hit hard by an accounting error which saw its regulatory capital decrease, followed by the Federal Reserve suspend immediate cash outflows to investors. Another factor denting the bank's prospects was a huge $6 billion charge in Q1 FY 2014 pushing the bottom-line into the red zone. Investors fear that legal suits will continue to bleed the earnings in the quarters to come. However, it may be that the worst is over for the bank and one could benefit from this dip in price as a chance to invest in it.

Stock Price

Bank of America fell victim to some serious negative developments in April 2014. These developments have changed investor sentiment and caused the stock price to fall below $15 from a high of $17.92 in March 2014. The chart below shows the share has dipped by about 15% from $17.92 in less than two months.

(click to enlarge)

Source: Google Finance

How Much of the Negative Sentiment is Warranted?

The recent stock price fall was driven by two factors. I will discuss each of the separately and determine whether or not investor anxiety is justified.

1. Investor Remuneration

The bank reported it found an accounting miscalculation of $4 billion after announcing its Q1 FY 2014 results. The error caused the bank to calculate higher-than-actual capital. So, does this mean the bank, according to correct mathematical working, would fall below the regulatory capital amount? I do not think so. The bank is still well-capitalized and the error does not pose a threat to the bank on that front. The Federal Reserve has taken notice of this error and asked Bank of America to suspend its capital plan and resubmit it. The plan includes a $4 billion share buyback as well as raising the quarterly dividend from 1 cent to 5 cents. The capital plan clearly had value for investors but the accounting mistake has not dented Bank of America's financial health. Bank of America can submit the capital plan to the Federal Reserve by May 27, after which the Federal Reserve will have 75 days to respond. In my opinion, the Federal Reserve just wants to make sure Bank of America is in good financial health and should have no problem approving the capital plan once it is presented. So, the investor remuneration has surely been delayed but not revoked for ever.

2. Litigation Issues

The bank has been troubled by a number of lawsuits over the past few years. The most recent quarterly result shocked investors with a $6 billion charge for litigation losses. However, after close analysis it becomes evident that $3.6 billion of this $6 billion was utilized to settle Federal Housing Finance Agency claims. Since the suit has been troubling the company since October 2012, closing these claims should be a relief. Also, the bank has revised its estimate for aggregate range of possible litigation losses from $6.1 billion. This is a good sign and shows the bank's management is hopeful about a less expensive resolution of the remaining claims.

A Turnaround is Imminent

So, increased dividends and share repurchases should be offered to investors soon and the worst seems behind the bank as far as legal suits are concerned. The recent stock slide of 15% seems less than rational and provides a good opportunity to purchase the stock at cheap levels. The company's core business looks fundamentally strong and the Q1 FY 2014 results of $0.05 LPS would look so much better without the $0.40 per share litigation loss.

Conclusion

The stock has more than discounted the bad Q1 FY 2014 results and delay in the capital plan. Bank of America is currently trading in oversold territory. A recovery is imminent due to strong fundamentals and we might see it immediately in the Q2 FY 2014 results. As per the Q1 earnings release, the bank has a book value of $20.75 and a tangible book value of $13.81. With a price of around $14.9 as of May 09, 2014 Bank of America is trading at 0.72x of its book value compared to 1.0x for JPMorgan Chase & Co (NYSE:JPM) and 3.2x for Wells Fargo & Co (NYSE:WFC). The discount was caused by the uncertainties associated with the bank's litigation issues but after recent updates in the bank's 10-Q filing the uncertainties have significantly reduced. I would recommend buying the stock for a rally to $18 and above.

Source: Bank Of America: Turnaround Is Imminent