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Bank of America Has 37% Upside: Morgan Stanley (Update 2)

Updated from 10.29 a.m. EST with afternoon market action ad commentary, stock ratios for the "big four" U.S. Banks, and comment from Deutsche Bank analyst Matt O'Connor, and.

NEW YORK ( TheStreet) -- It's been a rough ride so far this year for Bank of America's (BAC - Get Report) investors, but the company is set for a major earnings rebound next year, according to Morgan Stanley analyst Betsy Graseck.

Graseck on Tuesday upgraded Bank of America to an "overweight" rating from an "equal-weight" rating, while raising her price target for the shares to $16 from $13. The new price target represents 37% potential upside from Monday's closing price of $11.72. The analyst raised her 2013 earnings estimate for the company to $1.07 a share from $1.01, and her 2014 earnings EPS estimate to $1.43 a share from $1.30. Looking further ahead, the analyst expects Bank of America's earnings to rise to $1.98 a share in 2015.

Bank of America's shares were up 3.5% in afternoon trading to $12.13, leading the financial sector higher. The KBW Bank Index (I:BKX) was up 2% to 55.73, with all 24 index components showing gains. Financial stocks were also boosted by a report from the Federal Housing Finance Agency that its House Price Index was up 0.7% in February from January, and that house prices in the U.S. were up 7.1% in February from a year earlier. The U.S. House Price index was still 13.6% below its peak in April 2007, right before the housing bubble burst.

"We see an earnings inflection point based on the convergence of visible cost cutting, rising [home prices] driving mortgage originations, reduction in legacy assets and shrinking tail risks," Graseck said in a note on Bank of America to clients on Tuesday.

"You don't get a lot of second chances in life," she wrote, "and so we are taking advantage of this one ... BAC is about to deliver on a significant expense reduction over the next several quarters, which should fall to the bottom line and boost EPS. Also, we expect BAC will be largely through significant litigation risk by YE2013."

Bank of America's shares returned just 1% year-to-date through Monday's close, compared to a 7% return for the KBW Bank Index. During 2012, Bank of America's stock more than doubled, as investors grew confident that the company would be able to work past the mounting mortgage repurchase demands, mainly resulting from a disastrous decision by former CEO Ken Lewis to purchase the troubled Countrywide Financial in 2008.

A Disappointing First Quarter

Investors were disappointed with Bank of America's first-quarter earnings report last Wednesday, as the company missed the consensus analyst earnings estimate of 22 cents a share. The shares dropped 5% that day.

Bank of America reported a first-quarter profit of $2.6 billion, or 20 cents a share, increasing from $732 million, or 3 cents a share in the fourth quarter, and $653 million, or 3 cents a share, in the first quarter of 2012. Pretax results for the fourth quarter had been lowered by $2.5 billion in costs for independent foreclosure reviews, and $2.7 billion in charges related to the company's $10.3 billion settlement of a long-term dispute with Fannie Mae (FNMA) over mortgage repurchase claims.
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