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In late December last year, I wrote a piece on why I didn't expect Bank of America's (NYSE:BAC) fundamentals to propel the shares much higher for quite some time, despite the potential for the bank's fundamentals to improve drastically in the future.

It was definitely too low to short, although going long seemed wrong too, given general headwinds hitting the financial industry as a whole. Imagine my surprise when BAC became the best-performing ticker on the Dow Jones for 2012 and rallied right to the threshold I didn't think it'd cross for months! For the record, I wasn't expecting BAC to break $7/share, and it's trading at $7.13/share as of the end of January.

Sometimes it's easy to underestimate how quickly hope and oversold conditions can turn the tides, and that seems to be exactly what happened to BAC. After enduring a bunch of violent selloffs in 2011, BAC shareholders are finally seeing what appears to be the light at the end of the tunnel.

The bank finished 2011 with a pretty solid Q4 report, which was even marred by a spike in litigation expenses ($1.5 billion versus $0.5 billion in Q3 2011). Another perk was the bank's successful auction of about $3 billion worth of China Construction Bank shares, which should help solidify the bank's balance sheet. Deposits were also up year-over-year, with $417.1 B relative to $413.2 B in Q4 2010, representing a 0.9% increase despite the growing popularity of credit unions.

Despite this, the results weren't perfect. Some divisions are still struggling as credit quality remains in focus. BAC's Card Services division was profitable for the year of 2011 (versus steep losses from 2010), yet the total pool of loans has shrunk approximately 11% to $121.1 billion. While the bank's emphasis on credit quality could've factored in heavily, the divison's net income still went south in Q4 2011 relative to Q4 2010 as a result. Clearly this is a trend we want to see reverse itself.

The Consumer Real Estate Services division struggled too. Mortgage rates fell for the entirety of 2011, which reflected the continuing contraction of the housing market. Despite a hint of a recovery in mortgage applications, emphasis on credit quality has prevented any real turnaround from flickering to life. The division had a 6% decline in total mortgage loans in Q4 2011 versus Q4 2010, and an even bigger 7% decline when averaging all four quarters of 2011 against 2010.

In general, total loans are probably going nowhere (yet). CEO Brian Moynihan seems to want to draw investor attention into the bank's bottom-line (or EPS) growth, which I expect to significantly improve in 2012. More fat will be cut from the employee side, and we might see some significant cuts in those bonuses at Merrill Lynch (the rest of the industry is doing the same anyway).

So the real question is whether or not BAC's recent rally is overextended. Are we being too optimistic, given the firm's average results and difficult position? The answer depends on how long you want to wait. I think the real excitement for BAC will come when we see more loans flowing into the bank's balance sheet, and when we see credit quality become less of a concern in the general industry.

Bank of America stands to make gobs of money from traditional banking (and will hopefully make the Countrywide purchase worth it someday). When that industry is on the mend, we should see very impressive results in the stock market. Still, BAC's improved margins and efforts to rebuild itself seem to have intrigued a plenty of investors. We might see the shares recover 2011 losses sooner than expected.

Source: Jumping The Gun On Bank Of America