Should I Buy Bank of America? 3 Pros, 3 Cons

by Will Ashworth | January 9, 2013 7:00 am

Bank of America (NYSE:BAC[1]) took a big step forward on Jan. 7 when it announced a settlement with Fannie Mae (PINK:FNMA[2]) over ongoing repurchase claims for fraudulent mortgages sold by its Countrywide Financial subsidiary through Dec. 31, 2008. The $11.6 billion deal significantly reduces the bank’s legal liability, removing a large amount of drag on its stock price.

With a deal in hand, does it make BAC shares a good buy now? Let’s look at the pros and cons:

Pros

Stress Test: Analysts uniformly agree that BofA’s settlement with Fannie Mae is well timed. David George, Baird U.S. banking analyst, said this in a note to clients: “The Fannie Mae settlement and [servicing rights] sale reduce the uncertainty around the mortgage repurchase losses, timing for declining expenses, and balance sheet risks heading into the 2013 CCAR [stress tests].”

Not only does this shrink BofA’s mortgage risk, but regulators will be more inclined to approve increased dividends and/or share repurchases. That’s very good news for investors.

Mobile Banking: CEO Brian Moynihan pointed out in his presentation at a Goldman Sach‘s (NYSE:GS[3]) conference in December that mobile banking grew 30% in 2012 to 11.1 million users. With 40 million households banking with BAC, the cost savings available by moving the remaining 29 million customers to mobile is tremendous.

The savings from moving the average customer to mobile will more than offset the higher cost of personal service for the rich, who are responsible for the growth in BofA’s wealth management segment.

Cost-Cutting: Aanalyst Christopher Mutascio of Stifel Nicolaus believes BofA’s $8 billion in annual cost-cutting puts it in a league of its own. Mutascio projects earnings per share will grow by 30% in 2014, six times the rate for large banks as a whole. With revenue growth hard to come by, BofA’s proven ability to rein in expenses should bode well once it returns to more robust revenue growth.

Cons

Liabilities: Despite the Fannie Mae settlement, BofA isn’t out of the woods by a long shot. To date, it’s agreed to $43.5 billion in settlements, which includes Fannie Mae as well as its portion of the $8.5 billion agreement by 10 big banks regarding improper foreclosure practices in 2009 and 2010. That’s a huge amount of money considering that ongoing litigation with the Department of Justice and MBIA (NYSE:MBI[4]) is sure to knock that number ever higher. Estimates put those settlements at $3 billion or more.

Analyst’s Pick: Evercore Partners (NYSE:EVR[5]) has named Bank of America its top stock pick among big banks on 2013. Evercore believes BAC will hike earnings over the next few years, unlike Wells Fargo (NYSE:WFC[6]) and some other of the big banks that will experience softening earnings. Anytime analysts make any kind of prediction, I get very leery. Their track record is usually pretty poor.

Stock Has Doubled: Momentum investors will definitely disagree, but the fact that it gained 110% in 2012 compared to 37% for its peers should make investors pause before piling in.

CNBC guest blogger Brian Stutland, who runs his own investment advisory firm, wrote in December that he thought it was possible for Bank of America to double again in 2013, although he hedged his bet by recommending January calls instead of BAC outright. Stutland’s biggest concern: The bank’s earnings and revenues have been in decline on a year-over-year basis. Doubling from $6 to $12 is a lot easier than doubling again to $24.

Verdict

I’m not a fan of the big banks. They tend to be all over the place with less focus than I’d like to see. However, BofA’s deal with Fannie  shows at least some sort of plan for the future. With the bank expected to breeze through the coming stress tests, some pundits see a $1.60 per share annual dividend on the horizon. That would clearly bring investors running.

At this point, while I don’t see a double in 2013, I do feel the downside is minimal. For this reason I have to say it’s a buy.

As of this writing, Will Ashworth didn’t own any securities mentioned here.

Endnotes:
  1. BAC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BAC
  2. FNMA: http://studio-5.financialcontent.com/investplace/quote?Symbol=FNMA
  3. GS: http://studio-5.financialcontent.com/investplace/quote?Symbol=GS
  4. MBI: http://studio-5.financialcontent.com/investplace/quote?Symbol=MBI
  5. EVR: http://studio-5.financialcontent.com/investplace/quote?Symbol=EVR
  6. WFC: http://studio-5.financialcontent.com/investplace/quote?Symbol=WFC

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