Bank of America Is Halfway Home

NEW YORK ( TheStreet) -- The long, rough ride for CEO Brian Moynihan isn't over, but all decks should clear for Bank of America ( BAC) by the end of 2015.

Investors are pleased with Moynihan, sending Bank of America's shares up 24% this year through Wednesday's close at $14.32, after the shares more than doubled during 2011.

As we approach the five-year anniversary of Lehman Brothers' bankruptcy filing at the height of the credit crisis in 2008, it's fascinating to consider the radical transformation of Bank of America and the promise of future glory, as the company expects its earnings to "normalize" during 2015.

Mortgage Mess

It has been a very rough ride for the bank, ever since former CEO Ken Lewis decided in January 2008 it would be a great idea to purchase Countrywide Financial, just as the U.S. residential real estate market was showing signs of a coming collapse. At that time, Bank of America touted Countrywide's "broader mortgage capabilities, including its extensive retail, wholesale and correspondent distribution networks." To Lewis, Countrywide represented "a rare opportunity for Bank of America to add what we believe is the best domestic mortgage platform at an attractive price and to affirm our position as the nation's premier lender to consumers."

Since then, Bank of America ceded its position of top U.S. mortgage originator to Wells Fargo ( WFC). The bank announced its exit from the wholesale mortgage lending business in October 2010. By that time, it was obvious that during the real estate bubble, mortgage loans made through brokers tended to be lower in quality than mortgage loans made directly by banks. One wonders if Bank of America's due diligence before the Countrywide deal included a sampling of retail loans against brokered loans for underwriting quality.

The Countrywide acquisition eventually led to a very large increase in expenses for Bank of America as it built up a huge Legacy Asset Servicing staff to work through problem loans. The company also struggled to deal with mounting mortgage repurchase demands from investors, which peaked at $28.278 billion at the end of 2012.

Major mortgage settlements included a $2.8 billion settlement with Fannie Mae ( FNMAO) and Freddie Mac ( FMCC) in January 2011, followed by an $8.5 billion settlement with private investors in June 2011, which is still being contested by some investors, but was fully reserved for, at that time. Other major settlements included a $10.4 billion deal with Fannie Mae in January.

The company's most recent major mortgage settlement was with MBIA ( MBI) in May. According to a press release issued by Bank of America regarding that "comprehensive settlement," the bank agreed to pay the bond insurer $1.6 billion in cash and an additional $137 million to "remit to MBIA all of the outstanding MBIA 5.70% Senior Notes due 2034 that Bank of America acquired through a tender offer in December 2012." The bank also agreed to "terminate all of its outstanding credit default swap (CDS) protection agreements purchased from MBIA on commercial mortgage-backed securities (CMBS), as well as terminate certain other trades in order to close out positions between the companies."

As part of the innovative deal, Bank of America provided MBIA with a $500 million secured credit line. In return, MBIA agreed to issue warrants allowing Bank of America to purchase 9.94 million MBIA shares for $9.59 a share, which can be exercised at any time through May 2018. The warrants enable Bank of America to acquire up to 4.9% of MBIA's common shares.

In addition to all of the mortgage putback settlements, Bank of America, as the largest loan originator (including Countrywide) through the real estate bubble, agreed in March 2012 to contribute roughly $8.6 billion as part of the industry's $25 billion mortgage foreclosure settlement with state and federal regulators.

Wall Street Meltdown: Five Years Later:

Bank of America said its unresolved mortgage putback claims totaled $16.648 billion as of June 30, down from $17.135 billion the previous quarter, mainly reflecting the MBIA settlement. But the company estimates the actual losses on mortgage repurchase claims "could be up to $4 billion over accruals at June 30, 2013," according to its second-quarter 10-Q filing.

Brokerage and Asset Management

Lewis also was eager to acquire Merrill Lynch in September 2008, with Bank of America agreeing to acquire the nation's largest retail brokerage firm for $50 billion in stock, the same weekend that Lehman failed in September 2008. The deal was completed in January 2009, in exchange for $29.1 billion in common and preferred stock.

Bank of America issued 1.4 billion common shares for about $20.5 billion, to complete the Merrill Lynch acquisition.

Bank of America was among the group of nine large banks in October 2008 that were pretty much forced by former Treasury Secretary Henry Paulson to accept government bailout funds through the Troubled Assets Relief Program, or TARP. Bank of America initially received $15 billion in TARP money, followed by another $35 billion in January 2009, after the Merrill Lynch acquisition was completed.

Bank of America raised an additional $25 billion in common equity before completing its full repayment of TARP in March 2010.

Looking Ahead

One may wonder what Bank of America got for all of this, aside from the huge devaluation of shareholders.

For one thing, the company still has the largest U.S. branch network, even though Wells Fargo more than doubled in size through its acquisition of the troubled Wachovia in 2009. Bank of America also has the largest retail brokerage network, because of the Merrill Lynch acquisition, which also grew its investment banking business.

The bank's investment and brokerage service revenue totaled $11.4 billion during 2012, increasing from $5.2 in 2007. Investment banking revenue increased to $5.3 billion in 2012 from $2.3 billion in 2007. For the first half of 2013, the numbers looked very encouraging, with investment and brokerage revenue of $6.3 billion and investment banking income of $3.1 billion.

Moynihan is well on his way to realizing the $8 billion in annual expense savings through the "Project New BAC" efficiency program he announced during 2011. The company expects its annual expense savings to reach $6 billion by the end of this year.

With home prices continuing to rise and with so much progress being made working through nonperforming mortgage loans, Bank of America expects its annual Legacy Asset Servicing (LAS) expenses to decline by $7.2 billion through the end of 2015, from second-quarter levels.

Because of the expected normalization of Bank of America's earnings, analysts polled by Thomson Reuters on average expect to see the company's earnings grow from a consensus estimate of 92 cents a share this year, to $1.38 in 2014 and to $1.62 in 2015.

The consensus estimates don't show anywhere near that sort of earnings growth potential for the rest of the "big four" U.S. banks, which also include Wells Fargo, JPMorgan Chase and Citigroup ( C).

Based on 2014 earnings estimates, it would seem that Bank of America's expected earnings improvement is "baked-in." At Wednesday's market close, the shares traded for 10.5 times the consensus 2014 EPS estimate of $1.36. Shares of Wells Fargo -- the strongest earnings performer among the "big four in the aftermath of the credit crisis -- closed at $41.50 Wednesday and traded for 10.3 times the consensus 2014 EPS estimate of $4.02.

Shares of Citigroup closed at $49.60 Wednesday and traded for 9.1 times the consensus 2014 EPS estimate of $5.46. The cheapest name among the "big four" is JPMorgan, with shares trading for just 8.5 times the consensus 2014 EPS estimate of $6.11, when they closed Wednesday at $51.87.

There's no question that investors are applauding Brian Moynihan for a job well done, and after expenses are finally normalized, Bank of America can once again focus on growing its business.

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

-- 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 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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