Today we have a detailed argument in favor of a deeply discounted financial stock from Steve Christ’s The Wealth Advisory.
“On January 11, 2008, Bank of America Corp. (BAC, $9) announced it was acquiring sub-prime lender Countrywide Financial for $4.1 billion. Of course, this acquisition would end up costing Bank of America whole lot more than that.
“In fact, Bank of America has had to pay over $40 billion to settle various suits and claims against Countrywide. And the settlements still aren’t done. Bank of America still faces a decision on repurchase agreements, which would require B of A to buy back mortgage-backed securities that were sold without full disclosure of the risks. The total amount of these re-purchase claims run as high as $25 billion — but most analysts believe the actual number of any settlement will be anywhere from $5 to $9 billion. Bank of America says its maximum payout for claims is $6 billion. That’s a lot for sure, but Bank of America has the cash. It’s sold off more than $50 billion assets over the last couple of years.
“Yes, the Countrywide acquisition has been a disaster. It cost former CEO Lewis his job. But there should also be no doubt that Bank of America was pressured into buying out Countrywide the same way it was pressured to take on Merrill Lynch. Also, in our opinion, Bank of America should be commended for accepting responsibility for Countrywide’s crimes. The buyout was structured in a way that would have allowed B of A to put Countrywide into bankruptcy and thereby avoid billions in fines. The company did not do that — and instead, has met claims head-on. Many investors still view banks as risky due to questions about the dollar value of toxic loans on their books, but you should know that Bank of America has written off $105 billion in bad loans over the last four years. In addition to writing off bad loans, Bank of America has had to consistently put aside billions as loan loss reserves. This amount hit $50 billion at the end of 2009. Now loan loss reserves are down to $9 billion.
“That tells us Bank of America has greatly reduced its exposure to bad loans. Bank of America is also doing an excellent job or raising its Tier 1 capital ratios to meet new standards. Tier 1 capital requirements agreed to as part of the Basel III rules state big banks must be above 7% by 2018. Bank of America has already hit that mark. At 8.9%, B of A has one of the highest Tier 1 capital of any bank in the U.S. — higher than Citi, JP Morgan, and Wells Fargo.
“The last major overhang for the stock is the repurchase liability. It seems clear Bank of America will settle for a lump sum and that will end the litigation. We expect the final number to come in a bit higher than B of A’s own estimate of $6 billion — $7 to $8 billion is more like it. What’s more, we expect a settlement to be announced by the end of the year. This will be a major catalyst for the stock, and you can expect a 10% jump in the share price on the day this is announced. The repurchase agreements are the last uncertainty for B of A. Once it’s cleared, shares will rally.
How Cheap is Bank of America?
“According to its latest quarterly earnings report, tangible book value for Bank of America is $13.48. Tangible book value is also known as the ‘bricks and mortar’ value, meaning if B of A sold its buildings, customers, and other assets, they’d raise $13.48 per share. Tangible book value will inevitably be less than regular book value because it doesn’t account for good will or the effort required to build a business. B of A’s book value stands at $20.40. With the stock currently trading around $9.50, there’s no doubt it’s cheap when compared to tangible book value... JP Morgan, for instance, trades at 1.1x tangible book value; Wells Fargo trades at 1.5x tangible book. Bank of America would have to move 50% to 100% higher to trade at the same valuations as JP Morgan or Wells Fargo.
“In addition to the repurchase agreement overhang, there’s another big reason Bank of America doesn’t trade with the same valuation as JP Morgan or Wells Fargo: dividends. But as you’ll see, that could change soon. In what’s become an annual event, America’s banks will submit their capital plans for the next year to the Federal Reserve on January 7, 2013. In this report, each bank will outline how it plans to survive another financial crisis (if one were to occur). These ‘stress tests’ will also include plans to raise capital, as well as what the bank plans to do with the capital it has. For Bank of America, its plans for capital in 2013 will include a request to raise its meager dividend and maybe even a stock buyback. ...
“Not only that, but Deutsche Bank analyst Matt O’Connor has weighed in on the matter, too. He thinks Bank of America will propose a return of $1.481 billion in dividends to shareholders, plus $1.5 billion in share buybacks. That would mean a 1.3% per share dividend — or roughly $0.12 a share. For comparison’s sake, JP Morgan currently pays 3% and Wells Fargo pays 2.7%. ... Additionally, given Bank of America’s Tier 1 capital strength, we expect the Fed will grant a request to hike the dividend.
Bottom Line
“We believe the risk/reward scenario for Bank of America is attractive as it will get. All the clues that the company is on solid footing are there, yet the stock is still trading with a significant discount to its peers. Bank of America has traded between $7 and $10 for the majority of 2012. And while it might seem obvious to buy the shares on a move back toward the lower end of its trading range, we don’t believe there’s much chance for such a move to happen, given the near-term catalysts. The best plan for accumulating a position in Bank of America prior to January 7 is to buy in increments over the next six weeks. That way, you will have the opportunity to buy on weakness should it occur — but you’ll also have exposure if the stock keeps moving higher. Buy Bank of America at or below $9.50. Our one-year price target is $14 and our dividend projection is $0.16 a share.”
- Steve Christ, The Wealth Advisory, November 16, 2012