By Jay Smith
There have been conflicting reports as to why Bank of America (NYSE:BAC) CFO Bruce Thompson resigned. Some believe Thompson was fired, while others believe that Thompson voluntarily stepped down because he was not in line for the top job. Either way, BAC stock fell 1.8% on the news.
Bank of America's 1.8% decline is better than that of other banks with similar CFO resignations. When Wells Fargo (WFC) CFO Howard Atkins abruptly resigned in 2011, its stock fell more than 3%. Investors sold Wells Fargo stock first and asked questions later, because they feared that the CFO resignation meant there were latent problems in the bank. Instead of reporting problems, Wells Fargo reported excellent earnings in that year and in the year after that. Since the unexpected resignation, WFC stock is up more than 70%, making Wells Fargo the largest U.S. bank by market capitalization.
We believe that a similar situation will occur with BAC stock. Although the CFO resignation is not a positive news item, it will not stop Bank of America's earnings growth. The U.S. economy is very strong. The country's unemployment rate is just 5.5%, while interest rates could rise as early as September. A strong economy will drive loan growth, while rising interest rates will boast Bank of America's net interest margin. With the stock market trading near all-time highs and companies confident about the future, Bank of America's corporate division will see strong growth too. As the economy accelerates and interest rates rise, we see the bank's ROE rising to 10% and its earnings increasing to $1.50-2 a share. Based on the ROE improvement, we believe that Bank of America will trade at a slight premium to its book value over the next 12 months.
While management might not do it, we hope that Bank of America slims down. Part of the reason for the CFO resignation could be that the bank is just too complicated for a single person to manage. Small mistakes are bound to happen, and the stress levels are very high. If Bank of America spins off Merrill Lynch, it would greatly simplify the bank and make the financial statements easier to manage. Given where Goldman Sachs (GS) and Morgan Stanley (MS) are trading, a Merrill Lynch spin-off would unlock significant value for shareholders and give investors an opportunity to invest more into Bank of America's retail bank division. A spin-off would also please the Federal Reserve, which ultimately decides how much capital BAC can return to its shareholders.
Many smart investors are bullish on Bank of America. Warren Buffett is still the largest economic owner, having warrants for 700 million shares with an exercise price of $7.14 a share. Although Buffett has had many opportunities to cash in on his gains, he hasn't exercised a single warrant. Warren Buffett's continued investment is a vote of support for CEO Brian Moynihan and his management team. Other institutions, such as Bruce Berkowitz's Fairholme, have huge positions in the stock. We mention the hedge fund owners of Bank of America, because following hedge funds can generate alpha. Our research shows that the 15 most popular small-cap stocks among hedge funds have outperformed the market by nearly a percentage point per month between 1999 and 2012. We have been forward-testing the performance of these stock picks since the end of August 2012, and they managed to return more than 144% over the ensuing 2.5+ years and outperformed the S&P 500 Index by over 84 percentage points.
