Best Ideas: Bank of America

Bank of America (BAC) has substantially cleaned up its legacy mortgage exposures and the remaining costs associated with its housing exposure are finally quantifiable .  As housing improves at an accelerating rate, the bank’s credit quality will continue to improve, adding to the bottom line.  Finally, risks emanating from the housing bubble and the financial crisis are largely either behind the company, or baked into the stock price.  Steiner sees BAC as the best play on strong housing among the major financial institutions. 

 

As the financials sector emerges from crisis mode, BAC stock remains highly  volatile.  Investors tend to use price volatility as an indicator of a company’s fundamental stability.  Steiner believes observers are discounting key ratios that are standard factors in the analysis of financial companies, based on a fundamental misunderstanding of current risks.

The banks hold more tangible capital today than they have in many years – in some cases, more than they ever held.  Paradoxically, the market is using historical cost-of-capital calculations at a time when the whole risk profile of the sector has changed.  Banks – BAC in particular – hold lots of capital.  Tangible equity capital – not “risk-weighted capital” – is hard to manipulate.  

 

Investors remain focused on the risks of leverage – the excesses that brought down the system.  But Steiner points out, capital is the inverse of leverage.  High levels of capital equals low levels of risk.  Steiner says the market continues to charge a high-risk cost of capital at a time when risk is lower than it has been in many years.

 

Steiner believes the decline in volatility will dramatically reduce BAC’s cost of capital computation.  Investors should also see a significant improvement in the bank’s margins and, as volatility declines, will change the way they account for risk.  Steiner thinks this Best Idea has the potential to return 100% over the next one to two years.


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