Bank of America’s (BAC) shares have struggled since the acute phase of the financial crisis, plagued by bad mortgages and toxic mortgage backed securities acquired in the bank’s respective takeovers of Countrywide and Merrill Lynch, with the latter deal eventually toppling former CEO Ken Lewis. More recently, Bank of America and new CEO Brian Moynihan were embarrassed over spinning dividend hikes before receiving approval from the Federal Reserve which they didn't get[i], leaving the quarterly dividend at an anemic penny per share.
As a result, based on the close for last Friday, May 27 at $11.69, Bank of America’s shares have lost 23.3% of their value from their 2010 opening ($15.24), while competing big retail banks are all at or above their January 1, 2010 level: Citigroup (C), +21.9%; JP Morgan Chase (JPM), +2.4%; Wells Fargo (WFC), +4.2%; Capital One (COF), +39.8%; US Bancorp (USB), +12.6%; Sun Trust (STI), +35.5%; PNC (PNC), +16.4%; Regions Financial (RF), +30.2%; and BB&T (BBT), +6.3%. This raises the question of whether Bank of America shares are a bargain now. My view is yes based on the following factors:
- Controversy over Moynihan is overblown. The Fed’s denial of Bank of America’s proposed dividend hike sparked a fall in the shares. This was further aggravated by reports that now outgoing CFO Charles Noski, whose planned reassignment from the CFO spot was subsequently announced, didn’t review the disclosure statement about the Fed’s denial.[ii] Failing to include an executive whose role management already intends to change can be a natural side effect of reorganizing a leadership team, so however imperfect, the Noski situation wasn’t the kind of fundamental lapse that should bring Moynihan’s capabilities into question.
- Basic business plan is intact. Rising interest rates can be very beneficial for banks since as rates go up, banks can raise their lending rates more than they raise the interest they pay on deposits. And with interest rates at historic lows, up is the only direction to go, and Bank of America has been completely forthright about using its massive footprint to profit from the resulting wider spreads.[iii] JP Morgan Chase, though perhaps more muted in its discussion of the subject, also expects margins to increase when rates rise.[iv] In the resulting environment, BAC will finally have the opportunity to fully leverage its acquisition of 16,000 financial advisors then with Merrill Lynch,[v] which has so far dragged on the company because of the toxic assets that came with the deal.
- Legacy issues are being aggressively addressed. Moynihan has received favorable press for recruiting executive Terry Laughlin, who previously left Merrill Lynch after management rejected his calls to write down shaky assets, to fix BAC’s Countrywide legacy issues.[vi] While it’s still too early to judge Laughlin’s performance, the story lays the foundation for a favorable market reaction if the numbers show he is living up to his billing.
While the conventionally stated reason for why the Federal Reserve keeps interest rates low is to prevent choking off the recovery,[vii] an unstated public policy consideration may be that raising rates now would give the big banks too sweet a deal too soon after the financial crisis their bad bets fueled. Viewed in this light, it’s not surprising that the Fed said no to Bank of America raising dividends in March. But the big picture is not about getting permission to raise dividends before interest rates rise, but how much money BAC can make once the profit party from rising rates begins.
The Fed may not raise interest rates until 2012,[viii] but because low interest rates drag on the dollar – fuelling inflation as import prices rise – the Fed runs a risk by keeping rates too low for too long. A recent investor survey on when the Fed will make the move put predictions for the first quarter of 2012 first, with the fourth quarter of 2011 second.[ix]
Another clue of expectations that Bank of America will do well when rates rise is that despite the stock’s recent lows, earnings predictions are very strong relative to the share price. As of this writing, CNBC reports a consensus of $1.68 a share for 2012,[x] which at the current price would be a trailing P/E of 6.95, a little more than half the current banking industry average trailing P/E of 12.8.[xi] So if BAC meets 2012 earnings predictions and the shares rise to current industry P/E levels, the price would reach $21.50, an 84% gain.
The bottom line on Bank of America is that the execution risk going forward is heavily intertwined with a macroeconomic event favorable to the company – rising interests rates – that is virtually inevitable. It’s true that Moynihan is still a new CEO and that there have been some bumps, but none are that troubling when the situation is considered in its proper context. So, given how low the shares have trended relative to peers over the last 17 months, there’s a good case that rising interest rates will eventually lead to BAC outperforming.
[i] See Roy Harris, “Noski Interview Sheds Light on BofA 8-K Flap,” CFO World, April 18, 2011,
[ii] See “Noski Interview Sheds Light on BofA 8-K Flap,” above note i.
[iii] See in particular Brian Moynihan’s answer to a question from Ed Najarian of ISI Group during Bank of America’s Q1 2011 earnings call, April 15, 2011.
[iv] See “JPMorgan Chase & Co.'s CEO Discusses Q1 2011 Results - Earnings Call Transcript,” Q&A, April 15, 2011, where Jamie Dimon responds to a question from Ron Mandle of GIC here.
[v] See “Bank of America Corporation Acquisition of Merrill Lynch Call Transcript,” Seekingalpha.com, September 15, 2008.
[vi] See Dan Fitzpatrick, “A Bull in BofA’s Mortgage Portfolio,” Wall Street Journal, May 7-8, 2011, p. B1-B2.
[vii] See “Led by Oil, Commodity Prices Plunge,” Wall Street Journal, May 6, 2011, p. A4.
[viii] See “Led by Oil, Commodity Prices Plunge, above note vii.
[ix] See “AAII Survey: When Will The Fed Raise Interest Rates?,” Forbes.com, May 6, 2011.
[xi] See cnbc.com, earnings history and predictions for Bank of America (BAC), above note x.
Additional disclosure: I may add to long positions in BAC over the next 72 hours. This disclosure includes holdings of immediate family members. Disclaimer: The information provided in this post does not constitute professional investment advice, and should only be used in consonance with all available information, including the opinion of a professional adviser, to make an investment decision.