Tailwinds on the Horizon for this Baggage-Heavy Megabank

Ted is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When Bank of America (NYSE: BAC) acquired Countrywide Financial in the midst of the 2008 financial crisis, it became the largest mortgage originator in America. It also became the most targeted bank for litigation regarding mortgage underwriting. It is currently being sued by several federal and state agencies for Countrywide's role in the mortgage meltdown. The potential legal liabilities have caused Bank of America's market valuation to lag its peers, but tailwinds are on the horizon for the megabank.

Bank of America has $2.3 trillion in assets and approximately 285,000 full-time employees. The bank divides its operations into six segments: Deposits, Global Card Services, Home Loans & Insurance, Global Commercial Banking, Global Banking & Markets, and Global Wealth & Investment Management. It has a number one or number two position in nearly every service it provides.

Bank of America must increase its capital levels over the next several years to comply with new Basel III regulations set to take effect from 2013 to 2018. The stock has rallied since it became evident that the bank did not need to issue additional equity to reach the capital requirements, but a series of asset sales are on the horizon. Sales of non-core assets will make the bank more focused, but poor market conditions could result in suboptimal sale prices.

In addition to its low capital levels, mortgage litigation is the other major headwind facing the company. However, it appears that the market has already priced in most of the potential losses from litigation.

Bank of America currently trades at just 50% of book value; even Citibank (NYSE: C) trades at a higher multiple of book. JPMorgan Chase (NYSE: JPM) and Wells Fargo (NYSE: WFC) deserve to trade at a higher multiple due to superior balance sheets and earning power.

 

JPMorgan and Wells Fargo have already rebounded from the financial crisis and have now returned to pre-crisis return on assets, albeit with a lower leverage ratio. On the other hand, Bank of America was hit particularly hard by the crisis and is still in recovery mode.

As the nation's largest mortgage originator, Bank of America is well-positioned for a rebound in housing. If the bank can return to a 10% return on equity, its stock will be worth nearly double its current price. A housing rebound will also make its current balance sheet healthier and potentially decrease the need to raise capital through asset sales.

Alternative to Common Equity

Bank of America's stock price has become a lot more expensive since the financial crisis, causing some investors to shy away from it. The common equity still looks cheap, but the bank's TARP warrants look like a more attractive risk/reward. The 'A' warrants expire January 2019 with a $13.30 strike price. The 'B' warrants expire October 2018 with a $30.79 strike. The warrants come with a number of interesting features that are outlined in the prospectus. Investors willing to make a leveraged bet on BAC may want to take a look at these securities.


titans8904 is long BAC TARP 'A' warrants. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo & Company. Motley Fool newsletter services recommend Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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