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

CEO Brian Moynihan is leading Bank of America through a long-term cost-cutting program called "Project New BAC." The company expects to achieve annual savings of $1.5 billion per quarter by the end of this year, with annual savings of $2 billion a quarter by the middle of 2015.

Noninterest expenses for the first quarter totaled $18.152 billion, declining from $18.360 billion in the fourth quarter and $19.142 billion in the first quarter of 2012. The year-over-year savings of nearly $1 billion resulted mainly from Project New BAC initiatives.

The clearing out of repossessed property and general improvement in credit quality are also expected to continue leading to reduced expenses for the company. Bank of America said that excluding litigation costs and the fourth-quarter expenses from the foreclosure settlement, Legacy Assets and Servicing expenses -- that is, expenses from servicing nonperforming mortgage loans and maintaining repossessed homes -- declined to $2.6 billion in the first quarter from $3.1 billion the previous quarter and $2.7 billion a year earlier.

Deutsche Bank analyst Matt O'Connor in a note to clients on Tuesday said "while excluding litigation, one could argue that EPS was in-line, other banks were able to overcome higher one-off costs this quarter and still beat [earnings estimates] -- so overall, results at BAC felt weaker vs. peers."

Among the positive first-quarter developments for Bank of America listed by O'Connor was a slight increase in period-end loans in the first quarter from the fourth quarter, "compared to down 2% for the industry."

Time to Buy

When discussing the timing of her upgrade of the stock, Graseck wrote that "we see accelerating [expense] cuts more than offsetting remaining litigation risk," adding that "management is delivering on legacy asset servicing (LAS) expense saves sooner than expected, and expenses are about to drop q/q on lower incentive [compensation] and elimination of seasonal retirement [compensation]."

Following the completion of the Federal Reserve's annual stress tests in March, Bank of America announced it had received regulatory approval for common stock repurchases of up to $5 billion through the first quarter of 2014. The company was also approved to buy back $5.5 billion in preferred shares.

Graseck pointed out that Bank of America's Basel III Tier 1 common equity ratio of 9.4% as of March 30 was already above the fully phased-in Basel III requirement of 8.5%, "suggesting BAC has the firepower to sizably ratchet up capital return in 2014."

The analyst also expects Bank of America to reverse its pullback from the U.S. mortgage market. "We expect BAC will increase market share from 4.3% in 1Q12 to 10-12% over time as it reallocates resources and has increased capacity."
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