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 (
) -- It's been a rough ride so far this year for
Bank of America's
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
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
A Disappointing First Quarter
Investors were disappointed with Bank of America's
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
over mortgage repurchase claims.
Bank of America's first-quarter revenue totaled $23.7 billion, increasing from $22.5 billion a year earlier, and coming in ahead of the consensus estimate of $23.41 billion.
The Fannie Mae settlement led to a great reduction in the outstanding mortgage repurchase claims against the company. Unresolved mortgage putback claims against Bank of America totaled $28.3 billion as of Dec. 31. The bank's fourth-quarter earnings presentation implied that the Fannie Mae settlement would reduce the putback claims by roughly $12.2 billion, leaving about $16.1 billion in claims. But the company reported outstanding mortgage repurchase claims of $17.135 billion as of March 31, showing that new claims were continuing to come in.
Bank of America's first-quarter net interest income was $10.875 billion, increasing from $10.555 billion in the fourth quarter, but declining from $11.053 billion in the first quarter of 2012. Another positive quarter-over-quarter trend was that the net interest margin -- the spread between the average yield on loans and investments and the average cost for deposits and borrowings -- widened to 2.43% in the first quarter from 2.35% in the fourth quarter, although the margin was down from 2.51% in the first quarter of 2012.
First-quarter noninterest income totaled $12.833 billion, increasing from $8.336 billion the previous quarter and $11.432 billion a year earlier. The company's trading account profits rose to $2.989 billion in the first quarter, from $792 billion in the fourth quarter and $2.075 billion in the first quarter of 2012.
Bank of America followed the industry trend of declining mortgage revenue, with a sharp decline in its gain-on-sale margin for newly originated loans. The first-quarter margin was 3.26%, declining from 4.38% in the fourth quarter. First-quarter mortgage banking income totaled $1.263 billion, improving from a negative $540 million in the fourth quarter (because of the Fannie Mae settlement), but declining from $1.612 billion in the first quarter of 2012.
The bank's litigation expenses totaled $881 million during the first quarter, compared to $916 million the previous quarter and $793 million a year earlier. First-quarter litigation expenses included $500 tied to a settlement of a class action suit by mortgage-backed securities investors against Countrywide.
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
Following the completion of the
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."
According to Graseck, Bank of America will poach mortgage market share from
, "whose market share we already forecast to decline from ~35% at 1Q12 to ~20% by 2016."
"BAC's market share is already up 130 bp from trough levels in 1Q12 to 5.6% in 1Q13; we expect it to rise to ~7% by 4Q13, 8% in 2014, and 10-12% long term, in line with BAC's deposit market share but below BAC's peak market share of 18-20% in 2009-10 post exiting wholesale and correspondent channels," she wrote.
Based on Monday's close, Bank of America's shares were trading for 9.1 times the consensus 2014 earnings estimate of $1.29 a share, among analysts polled by Thomson Reuters. The consensus 2013 EPS estimate is 97 cents. That's a projected earnings increase of 33% for 2014, which is the highest among the "big four" U.S. banks, although, of course, Bank of America's estimated earnings increase comes from a pretty low base, with a first-quarter return on average assets (ROA) of 0.48% for the first quarter.
Here's how ROA and forward P/E ratios compare for the rest of the big four:
- Shares of Wells Fargo closed at $36.73 Monday, trading for 9.4 times the consensus 2014 EPS estimate of $3.90. The consensus 2013 EPS estimate is $3.70. The company's first-quarter ROA was a strong 1.49%.
- Shares of JPMorgan Chase (JPM) - Get Report closed at $$47.35 Monday, trading for 8.0 times the consensus 2014 EPS estimate of 5.93. The consensus 2013 EPS estimate is $5.67. The company's first-quarter return on assets was 1.14%.
- Citigroup (C) - Get Report closed at $45.15 Monday, trading for 8.5 times the consensus 2014 EPS estimate of 5.31. The consensus 2013 EPS estimate is $4.68. The company's first-quarter ROA was 0.62%.
Interested in more on Bank of America? See TheStreet Ratings' report card for this stock.
-- Written by Philip van Doorn in Jupiter, Fla.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.