We are upgrading our recommendation on Bank of America Corporation (BAC) to Neutral from Underperform as we believe that most of the negatives have already been factored into its current price. Also, the settlement of legacy mortgage claims is expected to remove much of the uncertainty associated with its potential mortgage repurchase liability.
BofA’s second quarter results were marred by outflow related to the settlement of legacy Countrywide mortgage repurchase and servicing claims. A lower top line and higher non-interest expenses were also among the negatives. Positives included lower credit costs, gains from the sale of non-core assets and debt securities, improved sales and trading revenues, as well as higher asset management and investment banking fees.
Management remains focused on managing asset levels efficiently. The company has relentlessly tried to realign its balance sheet in accordance with the regulatory changes post meltdown to remain afloat. In fact, BofA remains committed to shedding its non-core assets, even after repaying the bailout money it had taken as part of its participation in the Troubled Asset Relief Program.
Primarily, the company has been selling non-core assets to strengthen its capital position in order to reinstate dividend hike, meet the new international capital standards, focus on corporate borrowers and U.S. retail clients as well as strengthen investment banking.
BofA launched a company-wide efficiency initiative with a goal to improve earnings by lowering expenses, increasing revenue, strengthening risk control and making changes to allow better execution and customer service, while returning more value to shareholders.
The company will retrench about 30,000 workers under the first phase of its ongoing cost-cutting initiative –– Project New BAC. Overall, the company is making every effort to keep itself afloat. Measures like realigning the balance sheet in accordance with regulatory changes, shedding non-core assets to strengthen its capital position and the reshuffling of its top management to align its operating units per key customer groups vouch for its good business intention.
On the flip side, the lawsuitfiled by the U.S. Federal Housing Finance Agency (FHFA) for infringing commitments on the quality of mortgage securities sold to Fannie Mae and Freddie Mac is expected to significantly impact BofA’s financials in the upcoming quarters.
Along with Countrywide and Merrill Lynch, BofA was sued for selling mortgage-backed securities worth $57.5 billion. At such a crucial moment of fluctuating world economy, compensation of billions would make it difficult for BofA to gain ground any time soon.
With Bank of America’s plan to boost dividend in the second half of 2011 being turned down by the Federal Reserve in March following the release of the second round stress test results, investor’s confidence in the stock has been dampened.
Though the Fed has given the company another chance to submit a revised capital plan for its consideration, we do not expect Bank of America toachieve a stable financial state any time soon. Consequently, regulators will continue with their cautious approach.
However, BofA’s large-scale operations, improving credit quality and cost containment measures augur well for the company.
BofA currently retains a Zacks #5 Rank (a short-term Strong Sell rating). However, one of its competitors, Wells Fargo & Company (WFC) retains a Zacks # 3 Rank (a short-term Hold rating).
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