What I’m Buying: Bank of America

A couple of weeks ago, I wrote two articles about the CCAR portion of Federal Reserve’s stress tests for the big banks. The results and the subsequent stock price action were relatively good for my only big bank holding at the time, Wells Fargo (WFC). WFC stock reacted especially well to the results when compared to the other banking giants.

On the other hand, Bank of America  (BAC) is one of two banks (along with Goldman Sachs) that passed the stress test only after first modifying its original capital plan and re-submitting the modified plan in the days prior to the public release of the results. BAC’s officially released capital plan included a quarterly dividend increase from $0.01 to $0.05 and a $4 billion share buyback plan. At the end of the week last week, BAC closed down just over 7% from where it closed on the day the CCAR results were released just over a month ago. Then on Monday of this week, BAC dropped a bombshell on its shareholders by announcing that it had made a $4 billion accounting error in it’s CCAR proposal and would be suspending its dividend and buyback plan and resubmitting a revised capital plan to the Fed for approval.

Ah. Hmmm… Ok then.

In Bank of America’s defense, we’ve all been there before, right? You remember that you left $4 billion in your pants pocket when you dropped them off at the cleaners, and you know the girl that works there will just keep it when she finds it… Or you are doing your taxes, and you end up with a yearly income of $4 billion because of a typo where you unwittingly added 6 extra zeros. Or the professional appraisal that you got for your house is about $4 billion less than you anticipated. I mean come on: it has an in-ground pool for Pete’s sake!

All kidding aside, my first reaction to the BAC news this week was a head shake and a grin. There will always be a soft spot in my heart for Bank of America for two reasons. First, it is my personal bank. Second, I have made more money from trading BAC stock in my life than any other stock by a very wide margin. When I saw the stock had plummeted on the news to around $15 per share (about a 12% drop from a month ago), I immediately began digging for details.

As is often the case with bad news, the more I learned about the situation, the more it became apparent to me that the 6% one-day sell-off was an overreaction. Of course $4 billion seems like an ungodly amount of money to you and me, but the sad truth is that it is not very much money to Bank of America. In fact, even with the strict capital requirements in place for the big banks, the Fed was prepared to allow Bank of America to return over $4 billion to its shareholders in the form of dividends and buybacks. I assume that means that the worst-case scenario for BAC shareholders is no dividend hike in 2014 and no buybacks. But since this “accounting error” is (supposedly) a one-time deal, the future of the company remains on exactly the same track for 2015 and beyond.

I wondered if I was just missing something in the details until I read that Morgan Stanley analysts Betsy Graseck and Michael Cyprys pretty much agree with my assessment of the situation. In fact, the $4 billion didn’t affect Graseck and Cyprys’ 2014 EPS forecast  for BAC by a single cent! And, based on the assumption that the buybacks won’t be happening at all this year, they lowered their 2015 EPS forecast by a whopping 1.3%, about a fifth of the size of the price drop BAC endured on Monday alone! So yeah, I’d call that an overreaction.

So on Monday I took a relatively large position in BAC at $15.00. No shareholders ever want to hear the words “accounting error” and “suspended dividend,” and the market got spooked. I’ve written before about how strong of a driving force fear can be in the stock market, and overreactions such as this one happen rather frequently. At $15.00, BAC’s forward P/E ratio dropped back below 10 for the first time in a while, not to mention the fact that the P/B (price-to-book ratio) is now around 0.75. Those numbers are ridiculously low and indicate that traders are pricing in far more bad news than has actually occurred here. The market sentiment toward Bank of America is understandably pretty bad right now, and the uncertainty revolving around the re-submission of the capital plan might continue to weigh down the stock in the coming weeks, but, like it or not, these mega-banks tend to come out on top in the long run.

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