OK, so what if you made a $45 billion boo boo? Hey, what’s some small change between friends? That is what Bank of America (BAC) has paid out to date in settlements related, for the most part, to its ill-fated acquisition of Countrywide Mortgage. The latest chunk was announced yesterday – a mere $1.7 billion to MBIA (MBIA) – and it is a signal to be bullish on BAC.
I like two banks – Goldman Sachs (GS) and BAC. Goldman continues to employ the smartest guys in the classroom – the girls and boys who sat in either the front row or the last row. Bank of America’s problems come from things we know about – these kinds of settlements – not mysterious assets lingering on around its balance sheet. It is the second largest retail bank in the country — I bank there — and as a retail bank, Bank of America is actually larger than No. 1, JPMorgan (JPM). It has great customer service and a great website. And while earnings were very soft in Q1, it has a lot of presence in part of the country only just now recovering from the Great Recession.
It’s all about deleveraging
The bears argue the company had weak earnings in Q1. Maybe for a quarter, or perhaps two, but they were weak on purpose. The real story is that Bank of America is deleveraging. The bank’s long-term debt in 2010 was half a trillion; it is now $300 billion and falling. This in turn will produce a higher return on equity and higher profits and eventually enable the bank to start paying real dividends, currently a whopping four cents a share.
I have experienced their desire to deleverage firsthand. I have my home-equity line at BAC. It is rather large – I have twin sons in those expensive liberal arts colleges everyone is writing about – and I called to see what rate I would get if I converted it from my floating rate of 2.75% to a fixed rate. The answer was 7.75%. Yes, it is deleveraging. The bank does not want my loan on its balance sheet.
Let’s go back to that paltry dividend – that it is so low is meaningful for the future of the stock price. BAC has radically increased tangible shareholderequity since the financial crisis, enabling them to get permission in March, from the Federal Reserve, to buy back $5 billion in shares. This was a signal to the market: “We are healthy.” And, I believe, it also meant “We are going to do a lot more for shareholders as we make money and raise our core capital.”
To my mind, that means shareholders can not only look forward to more buybacks and a dividend hike, they can look forward to these events as catalysts to push the stock up in addition to news about the underlying business. I think the stock, currently around $13, is good for $22 in a year or two, just based on the performance of the company, not the stock market itself.