By some measures, Bank of America’s (BAC) stock is a screaming buy. It trades at levels not seen since the middle of last year, when the financial system had barely gotten out of intensive care. YCharts’ own proprietary valuation system suggests the stock is undervalued.
But the shares are cheap for a reason, holding big risk as the housing and job markets lag improvement in the economy. Bank of America says it serves one out of every two households and therein lies the danger. In a good economy, that’s massive earnings power. In this economy, that’s massive exposure to losses. BofA charged off $33.7 billion, or 3.58% of loans outstanding, last year. Lots of home loans, but other consumer and business credits, too. That hit profits.
Most worrisome, the bad loans are far from gone. BofA charged off $27.6 billion in the first three quarters of 2010. And it had another $34.6 billion in “non-performing loans” as of September 30. The bank has plenty of reserves for bad debt but that takes away from profit, and the ability to invest in new business.
There could be more problem loans. The Federal Reserve Bank of New York and other bondholders of $47 billion in mortgage-backed securities are demanding that BofA buy back some soured loans created by Countrywide Financial, the sub-prime lending giant Bank of America bought in 2008.
New BofA CEO Brian Moynihan boasts about market prowess — BofA is No. 1 or No. 2 in nearly every big business it’s in. It has, for instance, almost $170 billion in credit card loans. Yet that business is losing money this year. The bank took a $10.4 billion goodwill impairment charge against third-quarter earnings because, under recent U.S. financial reform, banks can’t charge fees on debit card transactions as aggressively as in the past.
BofA’s stock, measured as a multiple of sales, looks cheap. Investors need pay only 84 cents for every dollar of sales. Competitors look less cheap, but the risk profile isn’t as great for JP Morgan Chase (JPM) and Wells Fargo (WFC).
Once it works through bad loans, BofA may revert to being an earnings machine (something bullish Wall Street analysts predict). The question is: how soon?
Moynihan promises less volatile results. If he delivers soon, this could be a buying opportunity. But given the uncertainties, those with a low appetite for risk might stay away from BofA for now.