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Demonized BAC Set to Double in 2012

This 'fallen angel' should soar in the next year

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The stock I get asked most about right now is unquestionably Bank of America (NYSE:BAC). I don’t think there is even a close second. And I get why. BAC crashed from over $50 before the 2008 financial crisis down to $3, recovered with a bounce toward $20 in 2010 and is now back down to its lowest prices since March 2009 when the market bottomed.

At these low prices, the stock must be either a really good opportunity or dying company, and everyone wants to know which.

I view Bank of America as what I call in my new Little Book, a “fallen angel” — a company that was once considered widely owned and admired that has fallen monstrously out of favor with Wall Street and investors. Of course, a fallen angel could in reality turn out to be a money-devouring demon.

To tell the difference, we have to ask two critical questions: 1. What went wrong? And 2. Can it be fixed?

So What Went Wrong With BAC?

Bad mortgages. This wasn’t unique to Bank of America. A lot of banks made the same mistakes, one of the reasons for the 2008 financial crisis. BAC and other major banks were holding too many mortgage securities backed by subprime mortgages in an effort to stretch for yield. Making loans to unqualified borrowers is a bad idea no matter how you slice it, and the practice cost BAC and the industry billions.

Bad acquisitions. Coming in the throes of the financial crisis, the acquisitions of Merrill Lynch and Countrywide were certainly ill-timed, but they were ill-advised as well. Then-CEO Ken Lewis coveted Merrill and its franchise with retail investors, which he believed he was getting at a bargain price. However, the acquisition came right when Merrill’s business dried up and increased BAC’s exposure to subprime mortgages. Making a bad deal even worse, Merrill’s last CEO John Thain paid many of his bankers, traders and lieutenants bonuses that sparked outrage at a time when public money was being used to bail out banks. The anger was so great that some big public funds needed to sell as a “statement of objection.” Countrywide brought in additional mortgage problems and also suffered from ethical challenges to boot.

Bad balance sheet management. BAC did not have sufficient liquidity to meet potential obligations and demands from creditors. This is why Lehman and Bear Stearns went under — and why the whole banking system may have failed without the government’s TARP program.

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