Time to Bet on Bank of America

Shares of the giant bank are down 46% this year, thanks to the housing mess and worries about a global slowdown. At their current level, that's all priced in and more.

Investors pulled their money out of Bank of America with both hands last week, driving the stock to its lowest level since March 2009, as concerns about a slowing economy rattled the banking industry, and lingering losses from loans it made during the housing bubble raised fears that the bank would need to raise additional capital.

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timates and they're worth $14.70.

The bank has made some progress in cleaning up after the housing meltdown. It has bolstered reserves on its $939 billion loan portfolio to $37 billion. If loan performance doesn't get worse—a big if in many investors' minds—the bank won't have to increase those reserves and a major drag on earnings over the past few years will disappear.
Bank of America (ticker: BAC) has also improved its liquidity and its capital, with $400 billion of cash and liquid assets on hand and $1 trillion in deposits. The bank's earnings power was apparent in its second quarter results. Outside the residential mortgage area, the bank's businesses generated roughly $6 billion of net income, and each enjoyed lower provisions for credit losses.

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Recent Price	$7.19
52-week change	-45%
Revenue 2011E (bil)	$90.2
EPS 2011E	-$0.25
EPS 2012E	$1.47
Tangible shareholder equity (bil)	$128
Tangible equity/share	$12.65
Current Yield	0.6%
E=Estimate. Source: Thomson Reuters

But the good news has been overshadowed by the bad: the European debt crisis, a chaotic stock market and fears about global growth, which pushed U.S. Treasury yields down. That's to say nothing of the heap of lawsuits stemming from the mortgage mess.
Low interest rates are hurting net interest income at all banks. And a faltering global economy could mean the industry underwrites fewer securities, trades less, makes fewer loans and facse higher-than-expected loan losses.
Matt O'Connor, an analyst at Deutsche Bank wrote in a note last week that his $1.35 earnings estimate for Bank of America in 2012 could fall by 47 cents and his $1.75 estimate for '13 could be too high by 96 cents. Betsy Graseck, Morgan Stanley's bank analyst, lowered her 2011 earnings estimate by six cents, to 76 cents a share and her 2012 estimate by 29 cents, to $1.53 a share. She lopped her bullish target price by $2, to $15.

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Dan Picasso for Barron's

 Concerns also flared over a report last week that claimed the bank may have to lift its reserves dramatically to offset new problems with its residential mortgage portfolio. BofA's consumer real estate division racked up a $14.5 billion loss in the last quarter, hurt by a $12.8 billion increase in the representations and warranties provision. Reps and warranties basically promise investors in mortgages that the bank did its job in correctly underwriting the loan.

"At the end of the second quarter, Bank of America had approximately $18 billion to cover the recently announced $8.5 billion settlement with Bank of New York Mellon and other future representation and warranties repurchase liabilities," a spokesman wrote in an e-mail. Still, the firm has said it may have to boost provisions by up to $5 billion more.

Now for the Good News

Bank of America's businesses are growing smartly, but housing bubble loans are still dragging it down.

Business Segment	Net Income Q2 2011 (mil)	Chg From  Q2 2010
Deposits	$430	-36%
Card Services	2,035	146
Wealth & Investing	506	54
Commercial Banking	1,381	69
Banking & Markets	1,558	73
Consumer Real-Estate Svcs.	-14,520	NA
Source: Company reports

SOME THINK THAT NUMBER could go a lot higher. Last week Compass Point Research & Trading published a report estimating that BofA would have to boost reserves by another $25.7 billion. That's the most extreme estimate so far, and Bank officials disputed it hotly.
Ironically, the shares may have already priced in Compass Point's worst case scenario, which has BAC boosting reserves by $44 billion. Once that reserve increase is adjusted for taxes and divided by the bank's huge share base of more than 10 billion shares, tangible book value would be reduced by roughly $2.50 a share. That would still leave $10 a share in tangible book, estimates John McDonald, a Sanford C. Bernstein Research analyst. He has a $13 price target on the stock.
The other thing weighing on shares is a lack of confidence in Bank of America's ability to meet an increase in regulatory capital requirements by 2019 through retained earnings and the sale of assets. Under Basel 3, the bank's tier 1 ratio needs to be 3.5% in 2013.

The Bottom Line

A slew of bad news hammered Bank of America's shares to their lowest level since March 2009. Under even the most bearish scenario, they look cheap. Why they could rise 35%.

The bank's goal is to have a ratio of 6.75% to 7% by 2013 and to exceed capital requirements in all periods without raising equity. But the market is acting as if it needs to raise equity now to meet the requirements and be competitive with rivals like JPMorgan (JPM).
CEO Brian Moynihan failed to convince investors on a conference call last week that the bank had turned things around. But with tons of bad news priced into the stock, a few quiescent quarters may be all it takes to lift the shares out of their funk.