Bank of America May Be a Mess, But It’s a Pretty Good-Looking Mess
In 2012, Fortune Magazine named Bank of America (NYSE:BAC) CEO Brian Moynihan as one of the worst performing chief executives in the United States. Fortune made its claim based on the performance of the bank’s stock since Moynihan became CEO in early 2010. Between then and May 2012, when Fortune made its claim, Bank of America stock had fallen about 42 percent, the worst performance among its peers.
Since then, shares are up nearly 92 percent, pulling the stock’s performance up to a loss of just about 5 percent during Moynihan’s tenure as CEO. The rally since 2010 would have been enough to push the stock above breakeven for the observation period, but an onslaught of litigation and the inevitable mountain of legal and settlement fees as well as market and economic headwinds has pushed the stock down over the past few months.
But the economy continues to show signs of recovery and expectations that the Federal Reserve will finally begin tightening its monetary policy are strengthening. Since banks make money from lending at a higher interest rate than the rate at which they borrow, an increase in the federal funds rate is generally favorable for banks like Bank of America. As a result, analysts have become increasingly optimistic that Bank of America is well positioned to outperform in the coming year.
Both Morgan Stanley (NYSE:MS) and Deutsche Bank (NYSE:DB) have upgraded Bank of America stock to Buy from Hold. Deutsche Bank raised the target price to $18 per share from $16.50.
One of the main reasons analysts are hopeful about Bank of America is that unlike other major trading banks, it has limited exposure to fixed income, commodity, and currency trading. According to a note published by Morgan Stanley’s Betsy Graseck and Manan Gosalia and quoted by Barron’s, “(We) expect fixed income, currencies and commodities declines 20% year on year on lower volatility and lower FICC trading volumes. We estimate year on year declines across the board, most at JPMorgan Chase (25% year on year) and least at Bank of America (-11% year on year).”
Deutsche Bank’s Matt O’Connor pointed to an increase in capital market activity this year that could boost the bank’s revenue from higher advisory fees. According to Reuters, the U.S. has seen 2,164 mergers and acquisition deals in the first quarter valuing as much as $367 billion.
Bank of America did have an embarrassing first quarter, reporting net losses of $276 million or 5 cents per diluted share. The bank was forced to back out of its plans to increase its dividend from 1 cent to 5 cents and to repurchase shares worth $4 billion under its capital distribution program, owing to a major accounting blunder.
But many of the negative catalysts that affected the bank’s performance last quarter — like regulatory prosecutions and an increase in legal costs — have already been factored into the current stock price, and the bank is making the amends already. Bank of America is actively cutting expenses, as we saw in the first quarter, and it has been putting aside less money for bad loans. Non-interest expenses in the first quarter were down 6 percent from the same quarter a year back. Loan write offs were down by 45 percent, which indicates that the overall quality of credit has much improved.
Bank of America is currently trying to negotiate a $12 billion plus settlement with the Department of Justice to settle all outstanding federal and state investigations against the bank for selling questionable mortgage backed securities during the financial crisis, but this is unlikely to disrupt the bank’s long-term prospects.
“The bank is well-positioned to benefit from potential increases in capital market revenue, higher interest rates and an improving economy,” notes O’Connor. However, increased scrutiny by regulators on money laundering activities of banks “remains a meaningful risk for all banks going forward.”