The Bull Case for BofA Is Simple

 | May 17, 2013 | 1:00 AM EDT  | Comments
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Albert Einstein famously remarked that things should be kept as simple as possible and no simpler. The bullish case for Bank of America (BAC) is one that is best understood by keeping it as simple as possible.

For years, analysts have been very skeptical of BofA because of things like lawsuits, asset writedowns, capital ratios, and the like. Those are all very important variables, but the reality is that not even the smartest analyst can ascertain with any degree of accuracy what the outcome will be. So, the easy answer is avoidance. Highly respected Wall Street analyst Meredith Whitney, who wouldn't touch BofA at $7, called it one the most compelling ideas going forward when shares were trading for $11 or so.

Here's how simple the bull case for Bank of America is: People are buying more cars and houses, that's a fact. Just read the earnings reports for General Motors (GM) and Ford (F). The U.S. auto industry is showing tangible signs of strength. And many of those purchases require loans, the lion's share of which is going to places like BofA and Wells Fargo (WFC). Auto loans, historically, have had excellent risk profiles. But in this environment, with the tougher lending standards, today's vintage loans for all assets are of much higher quality than earlier loans. That means fewer future charge-offs and growing interest income.

Second, BofA is naturally hedged against the biggest axe facing the market today: rising interest rates. BofA sits on more than $1 trillion in deposits, money that it is holding for virtually no cost thanks to today's low-interest-rate environment. That $1 trillion deposit base more than offsets BofA's $900 billion loan portfolio, so the company's ability to make future loans is in no way limited due to financial constraints. And when interest rates start to climb, the interest banks can charge on loans (income) will grow faster than the interest charged on deposits (expense), so net interest margin will climb. BofA calculates that for each 1% increase in interest, its bottom line will benefit by $4 billion to $5 billion. For a bank with 11 billion shares outstanding, that's an incremental $0.35 to $0.45 in earnings per share. With shares trading around $13.50, you begin to see the embedded earnings power leverage.

Finally, CEO Brian Moynihan seems to be focusing on the right things, namely focusing on getting customers with more than $50,000 in investable assets to have multiple products with BofA. This strategy is right out of Wells Fargo's playbook and it has worked magnificently for Wells.

BofA is getting stronger and cleaner every day. If the recent settlement with MBIA (MBI) confirms anything it's that other outstanding litigation will ultimately be resolved in similar fashion. And the share price is still right against $15 in tangible book value, and if it matters to you, more than $21 in total book value. BofA could see earnings per share of more than $2 in 2015, which would be less than 7x earnings at today's price. And you know as soon as practicable, a dividend is coming that will draw in even more investors. By this time next year, BofA could be trading close to $20 as the market likes to anticipate future growth.

Simply put, the benefits of owning BofA in today's environment and in the future far outweigh the negatives.

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