3 Questions Bank of America Needs to Answer

NEW YORK ( TheStreet) -- Now that the company's survival seems assured, Bank of America ( BAC) CEO Brian Moynihan is on the hot seat, as investors wonder how the company will grow its revenue and earnings.

Over the past few years, Bank of America has been rightly concerned with shoring up its capital by shrinking its balance sheet, while cutting expenses and working through its legacy mortgage expenses from former CEO Ken Lewis's disastrous decision to by Countrywide Financial in 2008. The company must also worry about meeting the Basel III capital requirements, which won't be fully phased-in until the end of 2018, although there is plenty of market and regulatory pressure to meet the full requirements years earlier.
Bank of America CEO Moynihan must testify about the bank's integration of Countrywide Financial by May 18

Bank of America reported a Basel I Tier 1 common equity ratio of 10.78% as of March 31. The Basel III requirement is for large bank holding companies to have Tier 1 common equity ratios of at least 7 %, along with an additional buffer of up to 3.5% for "systemically important financial institutions."

Guggenheim Securities analyst Marty Mosby estimated in late April that Bank of America's Basel III Tier 1 common equity ratio would have been "at around 7.8%" as of March 31, rising to an estimated 8.5% by the end of 2012. Assuming that Bank of America would face an additional SIFI capital requirement of 2.5%, the company will be "about 1% shy" of its full Basel III requirement at the end of this year.

"As a result," said Mosby, "we expect BAC to continue to accumulate capital and de-risk the balance sheet over the next year and delay any potential raise in dividends until 2013 or 2014."

Bank of America's shares have returned 43% year-to-date, through Monday's close at $7.96.

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The shares trade for just 0.7 times tangible book value, according to Thomson Reuters Bank Insight, and for a low eight times the consensus 2013 earnings estimate of $1.05 a share, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is 62 cents.

Investors looking for signs of an earnings recovery for the company will want Moynihan to answer these three questions:

1. What is your estimate of Bank of America's potential remaining after-tax mortgage losses?

This unanswered question plays a big part in the heavy discount to book value for the shares. Obviously, with so many court battles with investors holding mortgage backed securities taking so many years, this will be a difficult question to answer.

But if Moynihan can make a clear and simple case that Bank of America has adequate legal reserves to navigate its mortgage putback exposure, and help investors become comfortable with this notion, a significant overhand for the shares can be removed.

Mosby said that "BAC's current discount to tangible book value per share represents the potential upside once the market decides that BAC can cover future losses from Countrywide's residential real estate overhang issues with future earnings." The analyst estimated "a range for potential remaining after-tax losses of $15 billion- $40 billion."

2. What about consumer loan growth?

Bank of America has, understandably, backed off from residential mortgage lending in a big way, further emphasizing what a terrible decision it was to purchase Countrywide, despite acquiring an industry leading mortgage origination platform.

While the company has reduced its balance sheet in order to shore up capital, investors will be looking for Bank of America to participate in the economic recover. During the first quarter, Bank of America's non-real estate commercial loans grew slightly from the previous quarter, to $193.7 million. The company saw declines in all other loan categories.

On Monday, the Federal Reserve reported that U.S. consumer borrowing rose at an annual rate of 7.75% during the first quarter, with non-revolving credit increasing at a rate of 11.5%. In March, consumer borrowing increased at an accelerated pace of 10.25%, with student loans and automobile loans accounting for the bulk of new borrowing.

During the first quarter, Bank of America's U.S. credit card balances declined 6% from the fourth quarter, to $96.4 billion. Meanwhile, indirect automobile loans made through dealers declined 7% to 40.2 billion and student loans declined 5% to $5.7 billion.

Moynihan needs to give investors hope that Bank of America will participate in the economic recovery.

3. How will you retain Merrill Lynch's top talent?

The Wall Street Journal reported last week that as part of Project BAC -- the company's massive cost-cutting program -- Bank of America was planning to lay off 2,000 senior staff in its investment banking, commercial banking and non-U.S. wealth management units.

With weak underwriting business in the U.S. and the company's need to right-size expense structure, the moves may well be justified, but an important concern for investors is morale at Merrill Lynch, which many consider to be BAC's crown jewel.

Moynihan needs to address investor concerns over the stability of Merrill's talent ranks. It would also help for the CEO to discuss where he sees opportunities for increased investment banking activity in the U.S., and how Merrill plans to participate.

Interested in more on Bank of America? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.

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.

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