Bank of America Has 30% Upside: Analyst (Update 1)

Updated with morning market action.

NEW YORK ( TheStreet) -- Atlantic Equities analyst Richard Staite continues to make the case for Bank of America's "near-term catalysts plus a good long-term earnings story."

After meeting in London with Bank of America CFO Bruce Thompson, Staite on Thursday reiterated his "Overweight" rating for Bank of America and $12 price target, saying that Thompson "expressed confidence that in Q4 there will be a decline in Legacy Asset Servicing costs, that mortgage delinquencies will decline and that the NIM will benefit from lower funding costs."

Following a brutal 7% pummeling on Wednesday in the wake of President Obama's reelection, Bank of America's shares led the market in morning trading on Thursday, with shares rebounding by 3% to $9.48.

Staite last month upgraded Bank of America from a neutral rating, as the company "has a bigger cost-cutting story, greater potential to reduce funding costs and faster improvement in capital ratios," relative to peers.

Bank of America's shares closed at $9.23 Wednesday, returning 67% year-to-date, following a 58% return in 2011. While the shares are trading at just 0.7 times their reported their reported Sept. 30 tangible book value of $13.48, it would appear that investors agree with Staite, since the shares trade at the highest multiple to forward earnings among the "big four" U.S. banks.

Bank of America's shares trade for 9.5 times the consensus 2013 earnings estimate of 97 cents a share, among analysts polled by Thomson Reuters. Here's a quick comparison of valuations for the rest of the big four:
  • Shares of Citigroup (C) closed at $36.05 Wednesday, returning 37% year-to-date, following a 44% decline last year. The shares trade for 0.7 times their reported Sept. 30 tangible book value of $52.70, and for eight times the consensus 2013 EPS estimate of $4.64.
  • JPMorgan Chase (JPM) closed at $40.46 Wednesday, returning 25% year-to-date, following a 20% decline during 2011. The shares trade for 1.1 times tangible book value, according to Thomson Reuters Bank Insight, and for eight times the consensus 2013 EPS estimate of $5.32. In addition to historically attractive valuations, JPMorgan's shares have an attractive dividend yield of 2.97%.
  • Shares of Wells Fargo (WFC) closed at $32.91 Wednesday, returning 22% year-to-date, following a 10% decline during 2011. The shares trade for 1.5 times tangible book value, and for nine times the consensus 2013 EPS estimate of $3.63. Based on a quarterly payout of 22 cents, Wells Fargo's shares have a dividend yield of 2.67%. Wells Fargo higher multiple to book value reflects the company's status as the best and most consistent earner among the big four, with operating returns on average assets (ROA) improving from 1.27% to 1.46% over the past five quarters, according to Thomson Reuters.

Bank of America continues to work through its legacy mess springing from the acquisitions of Countrywide Financial in 2008 and Merrill Lynch in 2009. The company reported a weak third-quarter profit, after booking $1.6 billion in litigation expenses, mainly from the settlement of a class action lawsuit related to the Merrill Lynch acquisition, as well as a charge of $800 million related to the reduction of a U.K. tax rate, and other one-time items.

In its quarterly 10-Q filing with the Securities and Exchange Commission, the company on Friday reported that its unresolved mortgage loan repurchase claims from investors totaled $25.5 billion as of Sept. 30, increasing from $22.7 billion the previous quarter, and $11.7 billion a year earlier. Staite said that the company's estimated $6 billion in losses to spring from the mortgage putback claims "manageable, particularly if pre-provision profits start on an upward trend, but we accept it is still an overhang for investors."

Bank of America continues to dispute mortgage repurchase claims from Fannie Mae ( FNMA), but Staite said "a settlement could be positive."

Two third-quarter bright spots for the company were its capital strength and its net interest margin, which is the difference between the average yield on loans and investments and the average cost for deposits and borrowings.

Bank of America reported an estimated Basel III Tier 1 common equity ratio of 8.97%, which is the highest among the big four, compared to 8.6% for Citigroup, 8.4% for JPMorgan Chase, and 8.02% for Wells Fargo. Staite said that "we think that the ratio could continue to improve," and that Thomson "highlighted deferred tax asset utilization, PE sales, financial investment sales, structured credit run-off and reduced mortgage delinquencies as factors to consider."

While Staite didn't offer any predictions on an increased return of capital to investors during 2013, Deutsche Bank analyst Matt O'Connor on Tuesday estimated that Bank of America would return a total of $2.981 billion to common shareholders next year, through $1.481 billion in dividends, plus $1.500 billion in share buybacks. The analyst expects Bank of America's 2013 dividend yield on common shares to be 1.3%. The company is currently paying a nominal quarterly dividend of a penny a share.

With the Federal Reserve keeping its target short-term federal funds rate in a range of zero to 0.25% since the end of 2008, most banks have already seen the majority of funding cost savings. Meanwhile the Fed in September increased its monthly purchases of long-term mortgage-backed securities by $40 billion, in an effort to hold long-term rates at their historically low levels.

Bank of America's net interest margin widened to 2.27% during the third quarter from 2.15% in the second quarter, according to Thomson Reuters Bank Insight, although the margin was still quite narrow, when compared to 2.42% for JPMorgan Chase, 2.84% for Citigroup, and 3.62% for Wells Fargo. Staite said that "BAC is somewhat unique among peers in having more high-cost long-term debt inherited from Countrywide and Merrill Lynch. However, this is running off ($28bn expected in 2013), resulting in a decline in funding costs."

Saite said that Bank of America's net interest income "will also benefit from trust preferred share repurchases ($50m in Q4 and $300m in 2013)," and said that Thompson "appeared confident that reduced funding costs will offset pressure on securities yields going forward."

The analyst is expecting major expense reductions for the company, saying that "the two key drivers of BAC's earnings over the next three years will be its success in reducing Legacy Asset Servicing (LAS) costs, which were running $10bn above normal in Q3 2012, plus the amount of the "New BAC" the name for the company's long-term cost-cutting plan $8bn in cost savings that drop to the bottom line."

Staite is way out in front of the consensus, estimating that Bank of America will earn $1.23 a share in 2013, followed by EPS of $1.53 in 2014.

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

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

>Contact by Email.

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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