by Dan Burrows | August 7, 2014 12:33 pm
Bank of America (BAC) stock got a nice bump Wednesday from reports that it’s close to a settlement with the Justice Department. BofA will pay a record $16.5 billion penalty and the four-year investigation into its sale of dodgy mortgage securities will finally come to an end.
As tough as the sluggish economic recovery has been on business and ultra-low rates have been on margins, the overhang of the federal investigation has been the most serious headwind for BAC stock.
The market knew the fine was going be big, but uncertainty over the final damage — and whether a settlement would even get done — was the real weight draped around BofA’s neck.
After all, the big financials all have the money set aside. They’ve already paid out $100 billion in fines since 2007. JPMorgan Chase (JPM) reached a similar settlement with the Justice Department for $13 million. And Citigroup (C) last month settled for a $7 billion fine.
Paying a record fine might sting on the face of it, but this is good news for anyone holding BAC stock.
In other good news for BofA shareholders, the company was finally able to raise its dividend. As expected, the Bank of America dividend went to 5 cents a share from 1 cent.
Like all the big banks, BAC’s capital plans — e.g., dividend hikes and share repurchases — were subject to approval from the Federal Reserve. The Bank of America dividend news is by no means a surprise, but it’s still a key milestone. Indeed, this is the first increase in the Bank of America dividend in seven years. Any concerns about BofA’s balance sheet or liquidity can be retired.
As good as the recent news for Bank of America has been these last couple of days, though, does it mean you should buy BAC stock? To help decide, let’s look at some of the pros and cons:
Settlement Relief: The Justice Department investigation was a huge headwind for Bank of America stock. Just getting this thing done is big catalysts for shares. BAC is one of the most heavily traded stocks in the market, but plenty of longer-term investors wouldn’t touch it until BofA put the investigation behind it. The settlement frees up buyers sitting on the sidelines.
Cost Relief: Bank of America has been enjoying remarkably stable operating performance, but the bottom line keeps getting ripped by legal costs. BAC also recently settled longstanding litigation with American International Group (AIG) for $650 million. By ridding itself of these outstanding legal expenses, Bank of America frees up cash and boosts its bottom line.
Solid Results: Bank of America’s operations have been pretty good this year. For the most recent quarter, BAC beat Wall Street’s estimates for earnings and revenue. It bucked the big-bank trend of reporting a decline in trading revenue — especially in the lucrative area of fixed income, currencies and commodities. And its wealth management business had a record quarter, crossing $3 billion in revenue for the first time.
It’s Still a Bank: It’s been a tough year for big bank stocks. Sure, Wells Fargo (WFC) is having a good year, but BofA and its closest competitors (with significant investment banking businesses) most certainly are not. BAC stock is off 4% for the year-to-date. Citigroup has lost 7%. Even JPM — arguably the best big bank stock — is down 4%. Financials are out of favor at this late stage in the bull market.
Volatility: When a stock bounces around a lot, it increases the risk of an investor buying high and selling low. BAC stock offers that risk in spades. With a beta of close to 2, Bank of America stock can be thought of as twice as volatile as the S&P 500. For comparison, WFC has a beta of 0.9, meaning it is less volatile than the broader market.
Competition: Sure, Bank of America has room to raise its dividend, but at 5 cents a share (so, 1.3%) for now, it’s pretty weak compared with WFC (35 cents, 2.8%) or super-regional US Bancorp (USB) (24.5 cents, 2.4%). Heck, JPM pays 40 cents (2.9%). Furthermore, banks that don’t rely on trading — like WFC and USB — have enjoyed much better market sentiment this year. WFC is up 11% YTD, while USB is off less than 2%.
If you’re bullish on stocks and the recovery, you should own a broad basket of banks and other financial sector names. After all, the economy and market aren’t going to go very far without the financials participating.
That said, if you’re looking to cherry pick among the big bank stocks, well … you can do better than BofA. It has made tremendous progress digging out from under the rubble, but JPM and WFC still look like better bets.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.
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