Despite the two-day super storm that forced the closure of the New York Stock Exchange's trading floor, investors continue to search for what they hope will be the next super stock. Surprisingly, one that a few pros favor is burdened by its own series of storms: Bank of America (BAC +0.95%).
B of A, the second largest U.S. bank, has been barraged by lawsuits, most recently from the U.S. Dept. of Justice, which accuses the bank of selling thousands of mortgage loans to Fannie Mae and Freddie Mac that ended up in defaults and foreclosures, costing taxpayers some $1 billion.
Many of the so-called toxic mortgage loans were issued by Countrywide Financial Corp., a big mortgage lender that Bank of America acquired in mid-2008 for $2.5 billion.
To be sure, B of A isn't anywhere near the top of Wall Street's favored-stock list, but it isn't necessarily at the bottom of the totem pole, either. A few analysts still recommend buying the stock, which hit an all-time low of $2.50 in 2009, but soared the following year to as high as nearly $20, before pulling back to $10 earlier in 2012.
Currently trading at about $9, some analysts see the stock rebounding to $12 over the next 12 months. The stock trades at just 45% of the bank's book value, and 70% of tangible book value, notes analyst Joe Morford of RBC Capital Markets, who rates it as outperform. Based on the bank's third-quarter results, which the analyst says beat his own forecast and the Street's consensus estimate, Morford raised his 2012 earnings estimate to 43 cents a share, up from 34 cents. For 2013, he is maintaining his profit forecast of 95 cents a share.
Although the bank, which has global assets of $2.2 trillion, booked "outsized" litigation expenses totaling $1.6 billion, its third-quarter numbers still managed to overshoot the most optimistic forecasts. "We see potential upside to BofA's earnings run-rate coming through lower credit costs, as the company further runs down its excess reserve levels," says the analyst.
Beyond that, the prospects of an improving economy and housing market could provide a significant boost to BofA's operating trends, "and if the company can ever successfully leverage its tremendous franchise, it could even post some meaningful revenue growth," Morford asserts. He acknowledges that the lingering uncertainties around litigation issues will require some time for the bank to return to more normalized earnings run-rates, but "we still see the shares as an attractive longer-term risk-reward play particularly given the significant discount valuation," says Morford.
Morford also raised his 12-month price target for B of A from $11 a share to $12, which represents a 20% discount to his increased 2012 projected tangible book value of $15 a share. He notes that revenues at the bank are stabilizing. Net interest income in the third quarter rebounded 4%, to $10.2 billion, led by an 11 basis-point increase in the margin to 2.32%. Moreover, loans actually grew for the first time in five quarters, "rising 0.1% as higher commercial balances offset ongoing consumer runoff," notes Morford.
Operating fees during the period were also impressive, he notes, rising 4% to $12.1 billion compared to his $11.5 billion estimate, with mortgage banking revenues up 11% sequentially, excluding a $175 million gain from a divestiture. Overall, Morford notes that operating revenues increased 4% from the second quarter, to $22.2 billion.
Of course, skeptics as well as outright critics abound when it comes to B of A's prospects and the outlook for its stock valuation. Some critics see the stock sinking to about $8 a share.
"We are reiterating out sell recommendation on Bank of America," says S&P Capital IQ's Erik Oja, who remains concerned that the bank will need to increase its liability (reserve) for mortgage buybacks, which he believes could cost billions of dollars. He notes that B of A's "representation and warranty reserve" stood at $16.27 billion as of Sept. 30, 2012, compared to unresolved buyback requests of $25.46 billion.
Jason M. Goldberg of Barclays Capital notes that while B of A is signaling it wants to return to a growth mode, and that expenses should decline in the fourth quarter, "the market could take a wait-and-see approach" towards the stock.
He acknowledges, however, that the bank has done "an impressive job improving its capital position." But he also argues that "meaningful expense improvement has yet to materialize," and that "revenue/balance sheet growth has been challenged." Goldberg rates BofA as "equal weight," with a price target of $10, based on headwinds that he sees for the stock as management "grapples with legacy and mortgage issues."
Indeed, all these concerns are valid and need to be raised, but that's one reason why the stock is already so depressed. Before the stock crashed to $2.50 a share in 2008, it was trading in 2007 at $54. So the bulls and investors buying the stock at current levels believe the worst is already reflected in its current valuation. Bank of America "is one of the greatest buying opportunities in the financials at its current price," says one institutional money manager who has been buying shares.