Bank Of America Is Changing

| About: Bank of (BAC)

Summary

With aggressive cost cutting and reduction in legal expenses, Bank of America could be seen as undertaking a massive transformation after surviving the crisis.

But BAC stock seems to be factoring in all the bad news with an almost 30% drop from the 52-week high.

Though its mistimed bet on Countrywide has hurt its franchise, under CEO Moynihan, BAC has been able to rebuild the bank with aggressive cost cutting, risk diversification, and strict Controls.

With aggressive cost cutting and reduction in legal expenses, Bank of America (NYSE:BAC) could be seen as undertaking a massive transformation after surviving the crisis. Though the rhetoric during the presidential debate has steered to breaking the "too big to fail" banks, it seems unlikely than ever. There have been talks of the economy being in a mess, but with sub 5% unemployment, the main street is chugging along just fine.

But BAC's stock seems to be factoring in all the bad news with an almost 30% drop from the 52-week high. One primary reason for the vast undervaluation is Bank of America's mundane improvement in performance metrics in spite of substantial consolidation. This is about to change as the statute of limitations expiring on liabilities and cost cuttings continuing further, it is the right time to jump in before it is too late.

Buffett effect

Recently, Warren Buffett had made optimistic remarks regarding the future performance of Bank of America and had reiterated his desire to exercise his option to buy 700 million shares of the bank worth $5 billion. With the purchase price via the option at $7.14 and the current price hovering around $12.8, the Oracle is anyways going to have a big winner on his hands. But his long-term commitment and positive remarks for the company highlight the opinion that the bank has turned the corner on a fundamental level. The risk diversification strategy has insulated Bank of America from extreme exposure to the energy industry. Though the company has lent around $21.3 Billion to the energy sector as per Q4 2015, it amounts to 2.4% of its total lending as compared to 5% for Morgan Stanley and 3.3% for Citigroup.

Buyback below book value

The company has recently announced a buy back for $800 million worth of shares. This is on top of the $4 billion buyback in the previous year. Considering that the company is currently trading at .57 times the Book Value, it is a very Buffet like move. In fact, some analysts are imploring the management to go for a more aggressive buyback taking advantage of the current mispricing. Its peer JPMorgan (NYSE:JPM) trades at almost 1.0 times the book value and Wells Fargo (NYSE:WFC) trades at a 40% premium to book value.

BAC Price to Book Value Chart

Project New BAC

The company is not only making financial changes to its capital structure but overhauling its entire business on an operating level. It has completed its Project New BAC, which will save the bank an estimated $8 billion every year in salaries and other operating costs. The project was initiated in 2011 and involved reducing the headcount by 30,000 and closing more than 700 branches. It was one of the first major initiatives launched by the current CEO, Brian Moynihan.

Relief from legal fines

The millstone around the bank's neck has been its legal difficulties. By one report, it has paid more than $100 billion in legal fines and settlements. The majority of these fines are related to its disastrous acquisition of mortgage lender Countrywide Financial in 2008. The company has paid through the nose for this acquisition, but the company seems to have finally laid to rest its legal troubles, with the statute of limitations expiring on liabilities and the bank releasing $7.6 Billion in legal reserves in the second quarter of 2015.

To make sure that its employees don't think that it is now business as usual, the bank has done some sweeping changes. The bank has now formulated various mechanisms to prevent and detect misconduct of sales and trading. Its sales and trading supervisors are required to review the online & offline chats of their employees' electronic communications so as to protect customer information and conflict of interest. Supervisors are also expected to reduce the problematic electronic communications and are made accountable for the same.

Catching up to competition

Now, if Bank of America is compared with other leading financial institutions such as Wells Fargo and JPMorgan Chase, we find the bank has still a long way to go. BAC's ROA is a paltry 0.7% as compared to 1% for JPMorgan and 1.3% for Wells Fargo. It is also way behind in ROE figures, with a 5.2% return as compared to 8.8 and 11.9% for JPMorgan and Wells Fargo respectively. Project New BAC was completed in the fourth quarter of 2015 and even after savings of $8 Billion annually, the company has not been able to catch up to its competitor's metrics, because of the huge legal bills and regulatory fines the company has had to pay after the financial crisis.

The full benefits of the consolidation efforts from the management should be seen on the bottom line in the coming quarters as the legal fines have almost ended and cost cuttings are about to continue that will further increase earnings and profitability going forward. The net income has increased from $4.83 Billion to $15.89 Billion and the company has a dividend yield of over 1.5%. In the last quarter of December 2015, the ABV (accounting book value) of the bank made an improvement of 6% from the previous year and was priced at $22.54. The growth in book value alone was $1.22 per share.

Conclusion

Bank of America is the second largest bank in America by assets. Despite the legal and regulatory stumbles, the company has an enormous market share in America's corporate finance industry. Though its mistimed bet on Countrywide has hurt its franchise, the company under CEO Moynihan has been able to rebuild the bank with aggressive cost cutting, risk diversification, and strict controls and compliance.

The company is focused on consolidation and profits and Moynihan seems to have shunned the excesses of his predecessors, their tenures marked with the motto of growth through acquisitions. The company has curtailed its Investment Banking and Sales & Trading units. Its focus is on reinventing itself more on the line of a conservative Wells Fargo.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.