Wells Fargo & Co (WFC), Bank of America Corp (BAC): Still Feeling the Impact of a Deal Gone Wrong

Back in 2008, perhaps everyone thought that Bank of America Corp (NYSE:BAC) was getting an excellent deal buying troubled Countrywide Financial for $4.1 billion. Maybe everyone remembered (difficult to forget) that it was the best performing stock from the financial services sector in Fortune 500’s list between 1982 and 2003: it had a 23.000% return. Although an astonishing performance, when the housing bubble burst in 2008 it practically destroyed the company: it is estimated that BofA’s acquisition cost $40 billion in suits, settlements and other litigation. This acquisition is still generating headaches nowadays.

Bank of America Corp (NYSE:BAC)

Bank of America Corp (NYSE:BAC)’s shares are trading at x11 2013 earnings compared to JPMorgan Chase & Co. (NYSE:JPM) and Citigroup Inc (NYSE:C) which are trading closer to 8.5x. Currently, it is overvalued as it is trading at 0.89x P/TBV (and a low ROE of 4.05%) compared to JPMorgan at 1.2x (ROE 10.7%) and Wells Fargo & Co (NYSE:WFC) at 1.6x (ROE 12.7%). Bank of America has a higher operating efficiency, a key issue in the banking sector and more nowadays in a revenue-challenged environment: 74.2% in 4Q12 compared to Wells Fargo’s 55% and JP Morgan’s 65%.

Let’s see some highlights that could indicate an improvement in the company, although they may take some time. Below you can find where the management is focusing in order to generate better results:

The settlement with Fannie Mae is the key for burying Countrywide’s issue. Bank of America Corp (NYSE:BAC) will pay around $11 billion to settle claims linked to mortgages. Also, the sale of Mortgage Servicing Rights (MSRs) will generate $306 billion of servicing assets being transferred out of the bank. Both actions could lead to $5 billion of cost savings in the coming years.

The company has announced a cost cutting scheme which could give $8 billion in total cost savings by 2015. This could help lower the efficiency ratio which is really important to reduce expenses and re-calibrate the expense structure.

It’s Tier 1 common ratio has improved substantially to 11.4% in 3Q2012. This is mainly due to improvement on RWA mitigation and in capital deduction items. This implies that management is actively trying to reduce risks in its portfolios. This ratio is in line with its peers: JPMorgan Chase & Co. (NYSE:JPM) at 10.4% and Wells Fargo & Co (NYSE:WFC)’s 9.9% for 3Q’12.

However, the company still shows signs of distress:

Bank of America Corp (NYSE:BAC) has incurred about $13 billion in litigation and legal costs in the past four years and these costs will likely remain high: ~$3 billion for 2013.

Taking into account the $5.5 billion allocated in 2011 for private label mortgages and adding the range of loss of up to $4 billion, this adds up to $9 billion in potential losses.

It is still heavily exposed to the mortgage business. If the housing market shows an improvement and credit quality gets better, it might have some upside as it could recover some of the loan loss reserves ($42.6 billion).

The bottom line

Bank of America Corp (NYSE:BAC)’s performance will depend on how quickly it can deactivate the Countrywide Financial issue. The Fannie Mae deal, the cost cutting scheme and the sale of the MSRs will definitely impact the company as it could give an aggregate saving of $13 billion. Total deposits at $1.1 trillion could help the company get better earnings if interest rates do increase in the next years. And as it is properly capitalized this could lead to a better dividend and payout ratio. However, it is still exposed to the housing market recovery and the economic upturn.

Damian Illia has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Bank of America, Citigroup Inc , JPMorgan Chase & Co., and Wells Fargo.

blog comments powered by Disqus
Insider Monkey Headlines
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months Click to see monthly returns in table format!

Lists

The Top 10 States With Fastest Internet Speeds

10 Best Places to Visit in USA in August

Top 10 Cities to Visit Before You Die

Top 10 Genetically Modified Food In the US

15 Highest Grossing Movies Opening Weekend

5 Best Poker Books For Beginners

10 Strategies Hedge Funds Use to Make Huge Returns

Top 10 Fast Food Franchises to Buy

10 Best Places to Visit in Canada

Best Summer Jobs for Teachers

10 Youngest Hedge Fund Billionaires

Top 10 One Hit Wonders of the 90s

Fastest Growing Cities In America

Top 10 U.S. Cities for Freelancers

Top 9 Most Popular Free iPhone Apps

Top 10 Least Expensive Private Business Schools in the US

Top 15 Most Expensive Countries in the World – 2014

Top Businesses to Invest In

Top 5 Things You Might Be Doing Wrong With Your Business

Top 5 Strategic Technology Trends in 2014

Top Rags to Riches Stories

Parenting Behavior That Promotes Future Leaders

Top 5 Mistakes Made by Small Businesses

Top 5 Most Common and Potentially Devastating Financial Blunders

Top 5 Highest Paying Jobs for Web Designers

Top 6 Most Respected Professions that Also Pay Well

Top 5 Pitfalls Investors Should Avoid

Top 6 Lawyers and Policy Makers Under 30

Top 6 New Year’s Resolutions for Entrepreneurs

Top 7 Locations to Check in on Facebook

Top 5 Mistakes made by Rookie eBay Sellers

Top 7 eBook Publishers in 2013

Top 6 Health Industry Trends in 2014

5 Lessons for Entrepreneurs from Seth Godin

Top 5 Success Tips from Jordan Belfort – the Wolf of Wall Street

Best Master’s in Finance Degree Programs

Top 6 Earning Celebrities Over 50

The most expensive sports to play

Top 7 Earning Celebrities Under 25

Best 7 Online Courses to Take: Free Finance MOOCs

Top 6 Bad Habits that Promote Failure

20 Most Valuable Soccer Teams in the World in 2013

12 Most Expensive Countries for Foreign Students

Top 30 Most Influential Women in the World

Top 20 Most Expensive New Year Eve Shows

Top 5 Best Vocational Careers

Top 10 Jobs for 2014 by Salary Gain (Predictions)

Top 5 Digital Trends for 2014

Top 6 Things You Can Do To Increase Your Productivity

Top 9 Trending Smartphones in 2013

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!