Upside catalysts ahead at Bank of America

Investors should buy these shares ahead of the next 'stress test' in January.

By TheStockAdvisors Nov 26, 2012 11:57AM

David Paul Morris Bloomberg via Getty ImagesBy Brian Hicks, The Wealth Advisory

Many investors still view banks as risky due to questions about the dollar value of toxic loans on their books. But Bank of America (BAC) has written off $105 billion in bad loans over the last four years. In addition, the bank has had to consistently put aside billions as loan loss reserves. This amount hit $50 billion at the end of 2009. Now loan loss reserves are down to $9 billion.

Bank of America is also doing an excellent job or raising its Tier 1 capital ratios to meet new standards. At 8.9%, B of A has one of the highest Tier 1 capital of any bank in the U.S. -- higher than Citi, JP Morgan, and Wells Fargo.

The last major overhang for the stock is the repurchase liability, which would require it to buy back mortgage-backed securities that were sold without full disclosure of the risks. It seems clear Bank of America will settle for a lump sum and that will end the litigation.

We expect the final number to come in a around $7 billion to $8 billion. What's more, we expect a settlement to be announced by the end of the year. This will be a major catalyst for the stock.

How cheap is Bank of America? With the stock currently trading around $9.50, there's no doubt it's cheap when compared to tangible book value of $13.48.

JP Morgan (JPM), for instance, trades at 1.1 times tangible book value; Wells Fargo (WFC) trades at 1.5 times tangible book. Bank of America would have to move 50% to 100% higher to trade at the same valuations as JP Morgan or Wells Fargo.

In addition to the repurchase agreement overhang, there's another big reason Bank of America doesn't trade with the same valuation as JP Morgan or Wells Fargo: dividends.

But that could change soon and the date to remember is January 7, 2013. In what's become an annual event, America's banks will submit their capital plans for the next year to the Federal Reserve on January 7, 2013.

In this report, each bank will outline how it plans to survive another financial crisis (if one were to occur). These "stress tests" will also include plans to raise capital, as well as what the bank plans to do with the capital it has.

For Bank of America, its plans for capital in 2013 will likely include a request to raise its meager dividend and maybe even a stock buyback.

Deutsche Bank analyst Matt O'Connor thinks Bank of America will propose a return of $1.481 billion in dividends to shareholders, plus $1.5 billion in share buybacks.

That would mean a 1.3% per share dividend -- or roughly $0.12 a share. For comparison's sake, JP Morgan currently pays 3% and Wells Fargo pays 2.7%.

We believe the risk/reward scenario for Bank of America is as attractive as it will get. All the clues that the company is on solid footing are there, yet the stock is still trading with a significant discount to its peers.

The best plan for accumulating a position in Bank of America prior to January 7 is to buy in increments over the next six weeks.

That way, you will have the opportunity to buy on weakness should it occur -- but you'll also have exposure if the stock keeps moving higher. Our one-year price target is $14.

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Nov 26, 2012 4:58PM
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