It's Time to Buy Bank of America
Ever since Bank of America (NYS: BAC) reported third-quarter earnings last month, an outlandish idea keeps recurring to me. It's so ridiculous, and perhaps even so intellectually embarrassing, that I haven't shared it with anyone, not even my wife -- though it's highly doubtful she'd care, despite the fact that we own shares in the bank. However, after turning the idea over and over in my head for nearly a month now, I've decided to go public with it.
Before doing so, let me say two things. To those of you who are new to the Bank of America party, what I'm about to say won't seem outlandish at all. That's awesome. You've probably aged less over the last few years than the people who'll think I'm an idiot. But to those of you who have either owned shares in the megabank, or watched it struggle to regain its footing since the financial crisis, I would beg of you to hold your laughter.
With that out of the way, here we go. I believe that Bank of America is out of the woods. It's healthy, it's well-capitalized, and it very soon should start turning a robust profit and distributing a portion of the earnings to shareholders. As a result, and assuming my hunch is accurate, those of you who have stuck with the bank over the last few years may very soon be rewarded for your patience.
The three aliments plaguing B of A
Since the financial crisis, there have been three principle forces holding Bank of America in check. The first concerned its portfolio of toxic loans. To give you some idea about the scale of this problem, over the last four calendar years alone, it has charged off a staggering $105 billion in bad loans, the majority of which were made to subprime borrowers. This is notably twice the figure that Wells Fargo (NYS: WFC) , now the nation's largest mortgage originator by leaps and bounds, charged off during the same time period.
The second force has been the liability accompanying its acquisition of Countrywide Financial, the largest subprime mortgage originator in the lead-up to the crisis. As recent as the second quarter of this year, Bank of America claimed to be unable to calculate its potential exposure to so-called repurchase claims from public and private investors in mortgage-backed securities populated by Countrywide's faulty mortgages. Taking a stab in the dark at the time, I accordingly estimated that it could fall anywhere between $4.7 billion and $40.9 billion. And this range didn't include costs stemming from the multitude of other lawsuits that Bank of America has faced over the last few years.
And the third force has been its regulatory capital level. Due, in large part, to losses related to the two forces just mentioned, Bank of America struggled for a considerable time to meet the now-heightened capital cushions mandated by financial regulators. In the now-annual stress test conducted last year, its tier 1 common capital ratio dropped to 5.7% after being subjected to a hypothetical scenario akin to the recent crisis. This placed it 15th out of only 19 banks. And it was dead last among the three other so-called too-big-to-fail banks JPMorgan Chase (NYS: JPM) , Citigroup (NYS: C) , and Wells Fargo.
Why it's out of the woods now
As I said at the beginning, however, there's solid evidence now on each front to be optimistic that the worst is behind Bank of America. With respect to credit risk, and to point to only one indication of this, its provisions for loan losses have dropped from nearly $50 billion on a trailing 12-month time period in the fourth quarter of 2009 to less than $9 billion over the most recent 12 months. Although this is still roughly double what it arguably should be, pre-crisis levels are now well within reach.
With respect to liability, while new lawsuits continue to trickle in, the lion's share are, if not already over and done with, largely provisioned for. The biggest and least appreciated relief in this regard was the bank's acknowledgement that its maximum exposure to repurchase claims is now capped at $6 billion in excess of allocated reserves.
Finally, with respect to capital, as my colleague Amanda Alix recently observed, Bank of America is now the best capitalized too-big-to-fail bank in the country, with a tier 1 capital ratio under the new regulatory guidelines of 8.97%. It should be noted, however, that the actual implementation of these guidelines was just pushed back beyond the beginning of next year, if not later. And to top things off, a global financial watchdog recently estimated the bank's regulatory capital ratio could be as much as one full percentage point less than similarly-sized competitors, like JPMorgan and Citigroup, both of which rely to a greater extent on riskier investment banking operations.
When we'll know if I'm right
I'm going to tell you exactly when we'll know if I'm right or not. At the end of last week, the Federal Reserve released the upcoming 2013 stress test instructions. Because the capital plans must be submitted by Jan. 7, we should know shortly thereafter whether or not Bank of America gets approval to increase its dividend or initiate a share buyback program -- either of which would serve as a massive catalyst for the bank's shares.
All this being said, I don't expect you to just take my word for all of this. To see why our senior banking analyst Anand Chokkavelu believes shares in the bank could "double or triple in the next five years," I encourage you to download our in-depth report on Bank of America. Given the impending deadline I just mentioned, you'd be wise to read it sooner rather than later. To access a copy instantly, simply click here now.
The article It's Time to Buy Bank of America originally appeared on Fool.com.John Maxfield owns shares of Bank of America. 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.