Bank of America Revised to $9, Banks Selloff Overdone

Investors have been watching Bank of America (NYSE:BAC) very closely recently as the troubled bank has raised numerous concerns on matters from the quality of its mortgage portfolio and a long-list of multi-billion dollar suits it faces, to its need and ability to raise additional capital to meet stringent regulatory requirements. As a result, the bank’s stock has shed nearly two-thirds of its value since the beginning of the year. And while much of the decline is indeed justified, we do not believe that the bank’s troubles even combined with the European debt situation, warrant the current market price of ~$5.50. We recently revisited our forecasts for the bank and revised our price estimate for the bank’s stock from $11 to about $9, which is still a healthy 60% above the current market price. We attribute this significant difference to the extremely pessimistic market sentiment toward the banking sector in general – as evidenced by declines in the stock prices of Citigroup (NYSE:C) and Goldman Sachs (NYSE:GS) – and Bank of America in particular. Below we explain the rationale for the revision in our price estimate for the bank.

See our full analysis of Bank of America

Mortgage Business Expected to Be a Drag on Value

Bank of America is one of the largest mortgage lenders in the country, and it significantly bulked up its mortgage business right around the time of the 2008 economic downturn with the acquisition of Countrywide. Any benefit this deal may have promised back then has been completely eclipsed by the poor quality of its mortgage portfolio.

Bank of America’s mortgage charge-offs for the period from 2008-2010 were nearly $27 billion with the figures for the first three quarters of 2011 standing at more than $6.5 billion. These write-offs are expected to continue for quite some time in the future. In order to be able to better understand the exact impact of these write-offs on the bank’s valuation, we have incorporated a new driver in our analysis that captures the provisions for losses as a percentage of loans outstanding.

Margins for Sales & Trading Operations Expected to Shrink

Extremely volatile global capital markets hit trading revenues for all global banks last quarter. Uncertain market conditions and the introduction of regulations such as the Volcker Rule are expected to put pressure on top-line figures for Bank of America’s sales & trading business. Moreover, the European debt crisis has resulted in banks having to write off portions of their sovereign debt portfolio in the most troubled Eurozone economies. These write-offs are expected to continue in subsequent quarters, further hitting trading margins in the near-term.

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