Finding Value In Bank Of America Shares

Since its shotgun marriage with Merrill Lynch back in 2008, Bank of America (BAC:NYSE) has struggled to deliver positive results to shareholders as it lumbers forward under the burden of legacy disputes arising from the last housing crisis and continued scrutiny over its business practices. This has contributed to the softness in the bank’s shares, which have been amongst the worst performers in the US financial sector. Hurt by falling revenues and a weak outlook for net interest income, the possibility of a shifting credit cycle could not come at a worse time for the bank as it struggles to impress shareholders with its litany of overhauls. With inherited problems still plaguing the Bank, sky high legal fees and never ending battles with regulators demanding their pound of flesh could continue to weigh on the outlook in spite of progress in other areas.

Fundamental Strides Not Translating to Share Price Upside

Performance of Bank of America has been lackluster to put it mildly, with shares plunging by -22.94% year-to-date, although trending modestly higher since hitting multi-year lows last seen in 2013 back in January. Although shares did manage to rebound 18.02% off the 52-week lows, the bounce may prove short-lived in spite of big picture improvements on the income statement. A quick look at the 5-year view of financials show that the bank has managed to go ahead and grow net income substantially, reaching $15.888 billion in 2015, climbing dramatically above the $4.833 billion reported in 2014.  During the same time period, earnings per share have risen from $0.36 in 2014 to $1.31 in 2015 in strong confirmation that the bank’s leadership is taking the appropriate steps to deliver value to stakeholders down the road.

However, the one disappointment from a balance sheet perspective is rising loan loss provisions. Although many of the settlements for improprieties during the subprime loan crisis have been resolved, helping to reduce legal costs for Bank of America, the new looming risk factor is in other lending areas, notably the bank’s exposure to loans in the energy exploration and production sector. As the energy industry begins to deleverage following the hangover from a borrowing binge that emerged on the back of rock bottom interest rates, banks with heavy exposure to the sector such as a Bank of America are expecting losses to be recorded in the upcoming quarters. Although debt servicing risks have been reduced modestly off the most recent rally higher in oil and gas prices, the long-term view is still weak as these indebted firms struggle to generate cash flow to repay these loans.

Strengths and Weaknesses Going Forward

While Bank of America has made considerable strides when it comes to cost cutting and improving efficiency, investors have not been impressed as evidenced by the sliding valuation. At present, shares are trading below tangible book value, or the measure of what would be leftover for shareholders if the company were liquidated currently stands at $15.16 per share, above the current share price. For value investors with a longer-term view, this might represent a great deal of opportunity, especially considering how Bank of America is performing relative to peers. Out of the major deposit taking institutions in the United States including JP Morgan (JPM), Wells Fargo (WFC), and Citigroup (C), Bank of America has notched by far the worst performance since the outset of 2015.  Although it trades at a slightly better price-to-earnings multiple than Citigroup, currently trending at 8.93 versus 7.09, it remains well below other peers, highlighting the preference of investors.

Even though a potentially interesting story for value investors, there are number of risk factors that will continue to weigh on share performance going forward. According to estimates released by Goldman Sachs, Bank of America has approximately $21.3 billion in exposure to the sector, the highest amongst its peers and the US banking system at large, although it only accounts for 2.40% of the total outstanding loans. Already the bank has preemptively added $500 million in reserves to provision against losses for the sector. From the perspective of interest rates, due to the overwhelmingly sensitivity to the Federal Reserve’s interest rate path, any deviation from the Fed’s trajectory could impact the bottom line for Bank of America. Exposure to loans and lending means that the bank will benefit from rising rates, however, should this outlook be revised downwards, it will undoubtedly impact the bottom line.

Expectations For Upcoming Earnings

Although the bar has been set pretty low for upcoming Bank of America earnings thanks to weak share performance, there is room for an earnings surprise in the first quarter. The impact of the woes in the energy industry could present a risk factor that could contribute to an earnings miss, but current estimates of $0.22 per share mark a substantial revision lower from 3 months ago when the figure stood at $0.32. Even though 2015 saw actual earnings beat consensus estimates in 3 out of 4 quarters, analysts might be a little more pessimistic than is currently warranted. Risks appear skewed mostly to the upside considering how weak share performance has been over the last few months. With an earnings disappointment already largely baked into the price, negative results are unlikely to have as dramatic an impact as an upside earnings surprise which could drive a substantial rebound in shares.