Is Bank of America’s Stock a Buy After This Upgrade?

   on November 20 2012 11:22 AM
The sign of a Bank of America branch
The sign of a Bank of America branch REUTERS

With shares of Bank of America (NYSE:BAC) trading between $9 and $10 since the company’s last earnings release, is BAC a BUY, a WAIT and SEE, or a STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement:

Bank of America has received a great deal of criticism regarding its mortgage-related acquisitions, namely Countrywide Financial and Merrill Lynch. The company was once the biggest bank in the United States in terms of assets, but a string of mortgage-related lawsuits forced the bank to shrink its balance sheet . So far, current Chief Executive Officer Brian Moynihan has attempted to make the bank a smaller and more efficient business. Yet in its coverage of the company, The New York Times stated that it “continues to be more troubled than the most of the nation’s other large banks.”

But Stifel Nicolaus analyst Christopher Mutascio has a different opinion; on Monday, the firm upgraded shares of Bank of America to a Buy rating and gave the stock a $11 price target, illustrating that industry sentiment is changing. In the accompanying research note, the analyst stated that the bank had “rebuilt its capital ratios much faster” than expected, an observation that was partly responsible for the bank’s upgrade. Mutascio now predicts that the company’s earnings per share could increase by 30 percent in 2014, while other major banks are expected to report growth of 5 percent. However, as Barron’s noted, “those estimates still depend on Bank of America whittling away at its massive mortgage servicing portfolio, which is hurting the bank’s attempts to cut costs.”

Under Moynihan’s leadership, the bank’s capital levels have improved, and Bank of America now ranks first among JPMorgan Chase (NYSE:JPM), Wells Fargo (NYSE:WFC), and Citigroup (NYSE:C). Since he became the company’s Chief Executive Officer in January 2010, Moynihan has made it his priority to build what he termed a “fortress balance sheet,” and on October 17, the day Bank of America released its third quarter earnings report, he declared victory. As the bank’s results showed, according to the rubric used by the Basel III regulatory standards, the bank had capital levels of 8.97 percent. Comparatively, Citigroup had levels of 8.6 percent in the last quarter, JPMorgan had 8.4 percent, and Wells Fargo had 8.02 percent.

The credit for the bank’s improvement is often given to Moynihan’s “Project BAC.” Named for the company’s stock market ticker symbol, the program was designed to make the company take less risk, generate more revenue from its existing customers, and become a more powerful player in international investment banking.

But not analysts are firmly convinced that Bank of America has put its troubled past behind it. Last month, following the third quarter results, Barron’s addressed what the publication termed the bank’s “mortgage mess.” On the company’s earnings conference call, executives focused on its “core earnings,” which they said were growing because of “improving mortgage origination.” However, Bank of America’s mortgage portfolio is as much a part of the company’s core as its healthier operations. Contrary to what executives said, Barron’s argued that mortgage servicing costs are wiping away efficiency gains that have come from Project BAC. The evidence is the bank’s earnings report, which showed that those costs were partly responsible $600 million rise in noninterest expenses.

Furthermore, Bank of America’s lawsuit load has been staggering. Even after five years, the federal government is still trying to assign blame for the mortgage crisis. These legal problems have put a strain on the company’s finances, costing the bank billions in write-downs and settlements. In September, Bank of America settled a shareholder lawsuit that accused the institution of hiding the full extent of Merrill Lynch’s losses. While the bank denied the allegations, it paid $2.43 billion to settle. In October, the Federal Government sued Bank of America, stating that the bank’s home loan program defrauded the government and encumbered taxpayers by generating thousands of fraudulent or defective loans. These lawsuits represent only a small portion of the litigation the bank has faced as a result of the financial crisis.

Even though the institution has worked hard to put its tarnished reputation behind it and Stifel Nicolaus analysts see a positive future for the company, Bank of America’s legacy mortgage problem are still part of the bank’s core business. Thousands of employees still handle litigation and repurchase claims, and its asset and servicing unit employes 1 in 6 of its workers.

Bank of America looks like a WAIT AND SEE based on the key metrics above.

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