November 28, 2011
Bank of America [NYSE: BAC]
Last Price
$5.25
Recommendation
BUY
Credit Rating
Baa1 / A
Sector
Financial Services
Industry
Banks - Regional
Presentation
The Ohio State University
SIM Fund
Student Analyst:
Edouard Sevil
Phone: (614) 940-046
E-mail: sevil.1@osu.edu
Bank of America is the second largest bank holding in the United States
with assets of $2,220 billion. The company was founded in 1904 and is
headquartered in Charlotte, NC.
Bank of America has been struggling in the wake of the financial crisis and
its acquisition of Countrywide Financial in July 2008 and Merrill Lynch in
January 2009. The bank in undergoing restructuration after posting a net
loss in five out of the last ten quarters.
Investment Thesis
Bank of America is struggling and faces many risks, mainly litigation and new regulations that arose from
the financial crisis. However, I believe that the bank is on its way to recovery and that its stock is severely
undervalued. It is trading near its 2-year low with a price down tenfold from its 2006 heights. While the
prospects for Bank of America are not as bright as they were before the crisis, my analysis shows that the
company is still worth much more than the $52.1 billion implied by the market.
A conservative analysis of discounted cash flows provides a valuation of $11.31 per share. I also found a
range between $10.22 and $10.60 using a multiple valuation. My one-year price target is $10.50.
Page 1 of 20
Beta
2.90
52-week low
$5.11
52-week high
$15.31
Shares outstanding
10.14 B
Market capitalization
$52.1 B
Annual dividend
$0.04
Dividend yield
0.78%
November 28, 2011
Table of Contents
Company Overview .......................................................................................................................................3
Business Segments .....................................................................................................................................3
Main Competitors....................................................................................................................................... 4
Project New BAC......................................................................................................................................... 5
Litigation .....................................................................................................................................................7
Eurozone Crisis ...........................................................................................................................................7
Occupy Wall Street Protests .......................................................................................................................8
Dodd-Frank Wall Street Reform and Consumer Protection Act ................................................................8
Basel III........................................................................................................................................................9
Berkshire Hathaway’s Investment..............................................................................................................9
Investment Thesis ........................................................................................................................................10
Discounted Cash Flows .............................................................................................................................10
Multiple Analysis ......................................................................................................................................13
Technical Analysis .....................................................................................................................................14
Conclusion ....................................................................................................................................................15
Appendix ......................................................................................................................................................16
Exhibit 1: Lawsuits Filed Against Bank of America and its Competitors...................................................16
Exhibit 2: Bank of America’s Capital Ratios ..............................................................................................17
Exhibit 3: DCF Model ................................................................................................................................18
Exhibit 4: DCF Sensibility Analysis ............................................................................................................19
Exhibit 5: Alternative Analyst Targets ......................................................................................................20
Exhibit 6: Analyst Bio ................................................................................................................................20
Page 2 of 20
November 28, 2011
Company Overview
Business Segments
Bank of America is structured in six business segments that offer a wide range of services to consumer
and business clients. This part will give a brief outlook of the activity and profitability of each of these
segments.
The Deposits division offers checking and savings accounts to consumers and small business in the U.S. It
serves approximately 57 million consumer and small business relationships in 32 states and the District
of Columbia through a network of 5,800 branches and 18,000 ATMs. 1 The Deposits segment consistently
contributes a small profit to Bank of America’s income statement.
Card Services provides credit and debit cards to consumers and small businesses in the U.S. The
company recently sold its international credit card business.
Global Card Services was particularly affected by the Consumer Protection constituent of the Dodd-Frank
regulation. Bank of America estimates that it will lead to an annual loss of revenue of $2.0 billion. As a
result, the bank recorded a $10.4 billion goodwill impairment charge in the third quarter of 2010. The
charge pushed the division in the red for 2010 but it remains structurally profitable. Delinquency rates
on credit cards have been declining for the 10th consecutive quarter. The 30-day and plus delinquency
rate went down from 5.69% in the first nine months of 2010 to 3.91% in the first nine months of 2011.
In an attempt to compensate for the expected loss of revenue, Bank of America announced in late
September 2011 that it would charge a $5 monthly fee to its debit card users. The announcement
provoked a massive uproar among clients and the bank published a statement one month later
explaining that it would not implement the measure.2 The bank did not disclose the number of clients
who left the bank during that period, but we may assume that the impact was significant enough to
prompt the bank’s volte-face.
Consumer Real Estate Services (ex-Home Loans & Insurance) provides financing and insurance for homeowners in the United States.
The bulk of Bank of America’s mortgage-related assets and activities are a legacy from the Countrywide
acquisition. Consumer Real Estate Services is the bank’s least profitable business segment: its year-todate losses totaled $18 billion as of Q3 2011. It has a structural profitability issue and is losing money for
the fifth consecutive quarter. Losses came from litigations issues and high default rates in the bank’s
mortgage portfolio.
1
2
2010 Annual Report, Bank of America Investor Relations website
Bank of America Will Not Implement Debit Usage Fee, Bank of America Investor Relations website (Nov. 1, 2011)
Page 3 of 20
November 28, 2011
In the last year, provisions for credit losses decreased by $384 million down to $918 million. This was
driven primarily by improving default rates in loan portfolios, including the Countrywide purchased
credit-impaired home equity portfolio.3
Bank of America announced at the end of October 2011 that it was exiting the Home Loans
correspondent mortgage lending channel and focusing entirely on retail distribution for mortgage
products and services. In correspondent lending, a bank originates and services the mortgage for a fee,
but does not hold it in its book. This business presents a high legal risk as investors may force the bank to
repurchase the loans if it misrepresented their quality. In 2010, correspondent lending accounted for
25% of the $10.7 billion unresolved mortgage repurchase claims that the bank was facing.4 After it failed
to find a buyer, the bank is expected to simply close the business. This will entail a major loss of revenue
for the Consumer Real Estate Services division. Correspondent lending accounted for about 50% of the
bank’s mortgage lending in the second and third quarters of 2011.5 The bank’s market share in the
mortgage business is expected to fall to 8.5%. Bank of America’s market share jumped from 7.8% to
24.6% when it acquired Countrywide in 2008.6
Global Commercial Banking provides a wide range of financing and investing solutions to corporations
and governments. It has very good margins, usually around 50% and is a very profitable business.
Global Banking & Markets is the investment banking arm of Bank of America. Most of its assets and
employees were originally part of Merrill Lynch.
While it is usually generates a profit margin around 20%, it showed a loss in the third quarter of 2011
due to a decrease in sales and trading revenues and investment banking fees.7
Global Wealth & Investment Management provides asset management and lending services to wealthy
individuals and institutions. It includes the wealth management activities under the Merrill Lynch brand.
The business segment is profitable but operates under constrained margins (around 10%). The segment’s
revenues grew by 8.9% in the nine first months of 2011 compared to 2010.
Main Competitors
JP Morgan Chase (NYSE: JPM)
With $2.22 trillion in assets reported in its 2011 third-quarter earnings, Bank of America now ranks
second behind JPMorgan Chase, whose assets total $2.29 trillion. JPMorgan Chase also ranks first in
terms of branches and total deposits.8 In September 2008, JPMorgan Chase acquired the investment
bank Bear Stearns and Washington Mutual, the largest savings and loans institution in the U.S.
3
Q3 2011 Earnings Report, Bank of America Investor Relations website (Oct 18, 2011)
Fortress May Pick Up BofA’s Correspondent Mortgage Unit, Trefis Team (Sept. 29, 2011)
5
BofA to Shutter Correspondent Lending Unit After Auction Fails, by Hugh Son, Bloomberg (Oct. 3, 2011)
6
Analysis - Bank of America's mortgage market share plunges, by Rick Rothacker, Reuters (Oct. 11, 2011)
7
Q3 2011 Earnings Report, Bank of America Investor Relations website (Oct 18, 2011)
8
Bank of America Loses Title as Biggest in U.S., by Nelson D. Schwartz, DealBook (Oct. 18, 2011)
4
Page 4 of 20
November 28, 2011
Citigroup (NYSE: C)
Citicorp and Travelers Group merged in 1998 to give birth to what is today the third largest bank in the
U.S. with assets of $2.00 trillion. 9
Wells Fargo (NYSE: WFC)
Wells Fargo acquired Wachovia in 2008 and is now the fourth largest bank in the U.S. with assets of $1.3
trillion.10
Source: Yahoo Finance
Market Cap ($ billion):
Employees:
Quarterly Rev Growth (yoy):
TTM Revenue ($ billion):
TTM Operating Margin:
TTM Net Income ($ billion):
TTM EPS:
PEG (5 yr expected):
BAC
52.40
290,000
17.60%
75.36
4.53%
-3.07
-0.31
21.87
C
69.09
267,000
18.00%
65.78
22.19%
11.01
3.75
0.5
JPM
108.16
256,663
3.60%
93.43
38.96%
18.55
4.69
0.71
WFC
123.98
263,800
2.20%
72.87
35.65%
14.37
2.7
0.63
The current market capitalization of Bank of America does not reflect the bank’s overall position in the
market. It ranks second behind JPMorgan in terms of revenue while its market capitalization puts the
bank in fourth position behind Wells Fargo, JPMorgan, and Citi.
Market Capitalization
Revenues (TTM)
124
108.2
93.4
75.36
69.1
BAC
JPM
72.9
65.8
52.4
C
WFC
Data in billion dollars
Project New BAC
In April 2011, Bank of America’s CEO Brian Moynihan unveiled “Project New BAC”, a plan to restructure
the company’s operations. 11 The bank’s efficiency ratio – a measurement of expenses to revenue – was
9
Q3 2011 Earnings Report, Citi Investor Relations website
Top 50 BHCs, National Information Center website
11
Moynihan Unveils Project New BAC, by Jim Kim, Fierce Finance (April 14, 2011)
10
Page 5 of 20
November 28, 2011
62 % in 2010. Moynihan told employees he wanted that number down to 55%. The bank already
announced plans to shut down about 10% of its 5,900 bank branches across the country.12
In a statement issued in September 2011, Bank of America mentioned that “Full implementation of
approved ideas […] is expected to lead to net expense reductions of $5 billion per year by 2014”.13 The
bank started in January 2010 a process of divesting non-core business units and assets that don't support
its strategy. The goal is to strengthen the balance sheet, and improve both capital and liquidity.
Phase I of New BAC focuses on a review of the bank’s consumer businesses and support functions. It
finished in October 2011. Phase II is ongoing and expected to last until March 2012. It will cover all
businesses that were not reviewed during Phase I.
In September 2011, CEO Brian Moynihan announced in a conference call that Phase I would be
accompanied by 30,000 layoffs.14 These reductions will boost Bank of America’s revenue per employee
by 12%, taking it above the level observed at Citi or Wells Fargo, but still 26% short of JP Morgan Chase’s
$364,000 per employee. A second round of layoffs can be expected during Phase II as revenues have
been depressed across the Banking & Market and Commercial Banking businesses. The number of
employees laid off in these divisions will probably be significantly lower, but the financial impact will still
be significant as the remuneration per employee on Wall Street tends to be much higher.
$400,000
$350,000
$300,000
$250,000
$200,000
$150,000
$100,000
$50,000
$Revenue / employee
New BAC
BAC
C
JPM
WFC
$289,846
$259,862
$246,367
$364,018
$276,232
In the last two years, the bank also sold 20 assets worth the market capitalization of Goldman Sachs.15
While none of these assets were essential to the business, the divestiture of its International Credit
Cards Business and its $8.3 billion stake in China Construction Bank still raise concerns on the bank’s
long-term international strategy.
12
Bank of America Wants YOU to Help Fix the Bank, by Dan Fitzpatrick and Shira Ovide, WSJ Blogs (April 12, 2011)
Bank of America Issues Statement on New BAC, Bank of America Investor Relations website (Sept. 12, 2011)
14
Bank of America Confirms 30,000 Layoffs, by Susanna Kim, ABC News (Sept. 12, 2011)
15
Bank of America’s Race to Sell, by Kayla Tausche, CNBC (Sept. 29, 2011)
13
Page 6 of 20
November 28, 2011
Litigation
In August 2011, the American International Group announced it was suing Bank of America over
hundreds of mortgage-backed securities. The suit claims that Bank of America and its Merrill Lynch and
Countrywide Financial units misrepresented the quality of the mortgages placed in securities and sold to
investors. It seeks to recover more than $10 billion in losses on $28 billion of investments.16
As of August 2011, the amount sought in the 25 lawsuits filed against Bank of America was higher than
the bank’s 2010 revenues (cf. Exhibit 1).
A $50 billion lawsuit was also filed in September 2011 by Bank of America shareholders. Plaintiffs include
the Ohio Public Employees Retirement System and the second-largest pension fund in Europe. They
claim that Bank of America and its executives, including former CEO Kenneth D. Lewis, failed to disclose a
$15.31 billion loss at Merrill Lynch in the days before and after the acquisition. The plaintiffs contend
that this staggering loss was hidden to ensure that Bank of America shareholders did not vote against the
transaction. The trial date is set for October 2012 but a settlement before that date is likely given the
amount of the claim.17
In November 2011, Bank of America settled securities fraud claims by a group of investors including the
California Public Employees Retirement System for an undisclosed amount.18
Although the total amount at risk is enough to wipe out roughly 40% of the bank’s capital, it is worth
noting that settlements can be made for a fraction of the original claim. In early 2011, Bank of America
settled a $127 billion lawsuit filed by Freddie Mac and Fannie Mae with a payment of $2.8 billion.19
It is hard to forecast losses on lawsuits as some may be won by Bank of America, other settled, and new
ones filed in the meantime. I believe that a range of $5 billion to $10 billion in the next five years could
be a reasonable estimate, with an average loss of $1.5 billion a year.
Eurozone Crisis
Bank of America’s direct exposure to the euro-zone crisis is “very small” according to Bank of America’s
CEO Brian Moynihan.20 Fitch published on Nov.16, 2011 a detailed report estimating the bank’s exposure
to $14.3 billion (cf. table below).
16
A.I.G. Sues Bank of America Over Mortgage Bonds, by Louise Story and Gretchen Morgenson, The New York
Times (August 8, 2011)
17
A $50 Billion Claim of Havoc Looms for Bank of America, by Steven M. Davidoff, DealBook (Sept. 27, 2011)
18
Citigroup, MF Global, JPMorgan, Merck, BofA in Court News, by Ellen Rosen and Elizabeth Amon, Bloomberg
(Nov. 23, 2011)
19
For B. of A., mortgage ‘put backs’ aren’t over, by Alistair Barr and Ronald D. Orol, MarketWatch (Jan. 3, 2011)
20
Bank of America CEO says Europe exposure small, by Rick Rothacker and Joe Rauch, Reuters (Oct. 5, 2011)
Page 7 of 20
November 28, 2011
However, the bank is impacted by the effect of the crisis on the markets. In the third quarter, the Global
Banking & Markets division recorded a 26% drop in revenue due to a slow trading environment and
uncertainty around the future of Europe21. The bank also sold its European credit cards activities this
year, contributing to lower its exposure to the region.
Occupy Wall Street Protests
The Financial Services industry has been under heavy scrutiny since the 2007 financial crisis. Retail banks
and investment banks played a major part in the creation and diffusion of subprime mortgages. The
industry as a whole has been pointed out as being responsible for the recession. Politics are under
pressure from the public opinion to take measures to regulate the industry. Instead of fading as time
went by, the pressure actually increased dramatically with the heavy media coverage of the “Occupy
Wall Street” protests that erupted in September 2011 throughout the United States. I will discuss below
the different regulations that have been implemented or are still under consideration.
Dodd-Frank Wall Street Reform and Consumer Protection Act
This bill proposes an overhaul of the financial sector. It mandates that the Federal Reserve limit debit
card interchange fees. Provisions in the legislation also ban banking organizations from engaging in
proprietary trading and restrict their sponsorship of, or investing in, hedge funds and private equity
funds, subject to limited exceptions. The Financial Reform Act increases regulation of the derivative
markets through measures that broaden the derivative instruments subject to regulation and requires
clearing and exchange trading as well as imposing additional capital and margin requirements for
derivative market participants. The Financial Reform Act also changes the methodology for calculating
deposit insurance assessments from the amount of an insured depository institution’s domestic deposits
to its total assets minus tangible capital; provides for resolution authority to establish a process to
unwind large systemically important financial companies; creates a new regulatory body to set
requirements regarding the terms and conditions of consumer financial products and expands the role of
state regulators in enforcing consumer protection requirements over banks; includes new minimum
leverage and risk-based capital requirements for large financial institutions; disqualifies trust preferred
21
Bank of America Loses Title as Biggest in U.S., by Nelson D. Schwartz, DealBook (Oct. 18, 2011)
Page 8 of 20
November 28, 2011
securities and other hybrid capital securities from Tier 1 capital; and requires securitizers to retain a
portion of the risk that would otherwise be transferred into certain securitization transactions.22
Bank of America is in the process of assessing the exact impact of the act on its operations. How the
regulator is going to enforce the bill is still under debate for certain business areas such as proprietary
trading. It is worth noting that Bank of America already recorded a $10.4 billion goodwill impairment
charge last year to reflect the expected impact of the regulation on its cards business.
Basel III
Basel III will ask banks to hold capital equal to 7% of their risk-weighted assets from 2019. Systemically
important financial institutions like Bank of America23 will have to keep that ratio somewhere between
1% and 2.5% higher.24
As of September 2011, Bank of America’s Tier 1 common equity ratio was 8.65% (cf. Exhibit 2). It gives
the bank a 165 bps advance on the Basel III basic ratio but might not be enough to cope with the
systematically important financial institution premium. In the worst case, the bank will have to reach a
ratio of 9.5% by 2019. This would mean adding 85 bps to its current ratio and would be an achievable
target, in my opinion.
Berkshire Hathaway’s Investment
In late August 2011, Berkshire Hathaway announced it planned to invest $5 billion in Bank of America.
The news gave a short-lived boost to the stock price. Under the terms of the deal, Berkshire will buy $5
billion of preferred stock that pays a 6 % annual dividend, and receive warrants for 700 million shares
that it can exercise over the next 10 years. Bank of America has the option to buy back the preferred
shares at any time for a 5 percent premium. Berkshire Hathaway has a good reputation as a value
investor, which corroborates my investment thesis arguing that Bank of America is undervalued.
Furthermore, the company only asked for a 6% annual dividend compared to 10% when it invested
comparable amounts in Goldman Sachs or General Electric.25 This leads me to believe that Berkshire
Hathaway is expecting considerable upside on the value of the stock.
22
Brief Summary of the Dodd-Frank Wall Street Reform and Consumer Protection Act, United States Senate
Committee on Banking, Housing & Urban Affairs website (July 1, 2010)
23
'Bucket' List: G-20 Panel Names Top Global Banks, by Geoffrey T. Smith, The Wall Street Journal (Nov. 5, 2011)
24
Basel III Summary Table, Bank for International Settlements website,
25
Buffett Invests $5 Billion in Bank of America, by Ben Protess and Susanne Craig, DealBook (Aug. 25, 2011)
Page 9 of 20
November 28, 2011
Investment Thesis
Discounted Cash Flows
Trends in Revenue
Billions
Revenue decreased across all business segments but Global Wealth Management & Investment in the
first three quarters of 2011 compared to 2010. Consolidated revenues fell 22%.
25.00
20.00
15.00
10.00
5.00
0.00
-5.00
-10.00
Revenues:
Jan-Sept 2011
Jan-Sept 2010
The main reason for that decrease is a general slowdown of the economic activity in the second half of
2011, due to uncertainty around the resolution of the crisis in Europe. There is no saying how long the
crisis will last but I estimate that it will have a significant impact on revenues from Global Commercial
Banking and Global Banking & Markets in the upcoming year. Quarterly revenue already fell by 9.9% and
23% respectively in the third quarter of 2011 as the situation in Europe deteriorated.
I expect the divestiture of some non-core businesses to have a negative impact on non-interest income.
In its third quarter earnings report, Bank of America moved its international card business to “all other”
and reclassified the previous quarters’ earnings accordingly. A quick calculation shows that the business
accounted for 12% of the Credit Cards segment revenues as of the second quarter 2011. The exit of the
correspondent mortgage lending business will also affect revenues of the Real Estate Consumer Services
segment. It is difficult to estimate the magnitude of the decrease as an important part of the division’s
revenues come from interest and fees on existing mortgages.
Interest income fell by 16% in Q3 2010 compared to Q3 2011. While the balance sheet shrank and the
bank’s total assets fell by 5.1% from $2,340 billion to $2,220 billion in the twelve months to September
2011, it is worth noting that the decrease in interest income was actually the consequence of a 12% drop
in the yield on earning assets, from 3.93% to 3.47%, more so than the decrease in the amount of average
earnings assets held on the balance sheet (-1.2%).26
Trends in Expenses
26
Quarterly Average Balances and Interest Rates, Third Quarter 2011 Supplemental Information, Bank of America
Page 10 of 20
November 28, 2011
Project New BAC should have a major impact on costs, with a target of saving $5 billion a year by 2014.
In my projections, I assumed that savings would be achieved as following: $2 billion between 2011 and
2012, another $2 billion between 2012 and 2013, and a final $1 billion between 2013 and 2014.
Noninterest expense started falling in the third quarter 2011. The $17,963 million recorded were down
23% from Q2 2011, and 35% from Q3 2010.
As Bank of America sells assets, it also repays debt and decreases the interest expense associated with it.
In the year to September 2011, the bank’s liabilities fell by 5.7% from $2,039 billion to $1,989 billion.
Short term and long-term debt decreased significantly. Short-term borrowings decreased by 22% while
long-term debt was down 17%.
(in million dollars)
Deposits
Trading account liabilities
ST borrowings
LT debt
$
$
$
$
Sep-10
977,322
90,010
361,423
478,858
∆ ($)
Sep-11
Yield/Rate
$ 1,041,353 $ 64,031
0.35%
$
68,026 $ (21,984)
2.47%
$ 281,985 $ (79,438)
1.51%
$ 398,965 $ (79,893)
2.82%
∆ Int. Expense
$
224
$
(543)
$
(1,200)
$
(2,253)
The increase in deposits allows the bank to get cheaper financing. The bank pays an average rate of
0.35% on deposits compared with 1.51% on short-term debt and 2.82% on long-term debt.27 I estimate
the total annual savings from the downsizing and restructuring of the balance sheet around $3.8 billion.
Assumptions
My assumptions include the trends discussed above and build on the numbers released for the first nine
months of 2011.
I made the following assumptions regarding growth in both net interest and noninterest income:
2013E
0.00%
0.00%
Growth in net interest income
Growth in non interest income
2012E
-5.00%
-5.00%
2011E
-20.00%
-15.00%
The relatively high negative growth rate for 2011 is based on the YTD figures and reflects the slowdown
on the markets as well as the loss of revenue from sold assets and discontinued activities. I still expect
negative growth in 2012 as Phase II of the New BAC restructuring is being implemented. I don’t expect
any growth in revenues before 2014.
Provision for credit losses as a % of net interest income
Growth in noninterest expense
27
2013E
25.00%
-2.00%
2012E
30.00%
-3.00%
2011E
30.00%
-9.00%
Quarterly Average Balances and Interest Rates, Third Quarter 2011 Supplemental Information, Bank of America
Page 11 of 20
November 28, 2011
Provisions for credit losses are down 55% YTD from 2010. I expect them to remain stable around 30% of
net interest income in 2012 and start to fall again in 2013 to the levels that were observed in 2007.
I projected a $3.7 billon decrease in annual noninterest expense between 2011 and 2013, in line with the
$5 billion target for 2014.
I also expect preferred stock dividends to increase to $1,600 billion a year. That estimate is based on the
current annual dividend of $1,300 million, plus $300 million paid to Berkshire Hathaway.
In building the discounted cash flow model, I made conservative assumptions regarding the terminal
discount rate and the terminal free cash flow growth rate.
Terminal Discount Rate
Terminal FCF Growth
13.0%
2.5%
A sensibility analysis is available in Exhibit 4.
Projections
Bank of America
(Dollars in millions, except per share information; shares in thousands)
Net interest income, FTE basis
Noninterest income
Total revenue
Consensus
FY
2013E
39,157
47,398
FY
2012E
39,157
47,398
FY
2011E
41,218
49,892
FY
2010
51,523
58,697
86,555
86,555
97,590
91,111
93,510
110,220
9,789
71,892
11,747
73,359
12,366
75,628
28,435
83,108
4,874
1,449
3,117
(1,323)
Provision for credit losses
Total noninterest expense
Income (loss) before taxes
Income tax expense (benefit)
Net income (loss)
1,462
435
3,412
1,014
Preferred stock dividends
Net income (loss) applicable to common shareholders
1,600
1,600
1,812
Per common share information
Closing share price
Earnings (loss)
Consensus
Diluted earnings (loss)
P/E
M/B value
Dividends paid
Average common shares issued and outstanding
Average diluted common shares issued and outstanding
$
$
$
$
15.00
0.18
1.33
0.18
84.6
0.04
10,212,654
10,212,654
Page 12 of 20
(623)
3,740
(586)
$
$
$
$
9.00
(0.06)
0.98
(0.06)
(156.0)
0.04
10,153,620
10,153,620
$
$
$
$
915
(2,238)
1,600
1,357
2,140
(3,595)
5.00
0.21 $
0.02
0.21 $
23.6
0.04
10,094,928
10,094,928
$13.34
(0.36)
(0.36)
(37.2)
0.59
0.04
10,036,575
10,036,575
November 28, 2011
EPS Estimates
Low
Average
High
2011
(0.48)
0.02
0.25
2012
0.54
0.98
1.65
My estimates are in the upper range for 2011
and below the range for 2012. This discrepancy
comes from my conviction that revenues will
decline between 2011 and 2012.
The full DCF model is available in Exhibit 3 and shows an intrinsic value of $11.31 per share.
Multiples
Historical Multiples
Bank of America is trading between the low and median for all five multiples. The target multiples are my
one-year targets.
Bank of
America
High
Low
Median
Current
1-year
Target
Multiples
Target
S and B
per Share
1-year
Target
Price
P/Forward E
83
5.8
11.1
5.8
#
#
#
P/S
3.8
.3
3.0
.6
1.2
$8.52
$10.22
P/B
2.8
.1
1.8
.3
.7
$15.14
$10.60
P/EBITDA
6.35
.57
4.43
.89
#
#
#
P/CF
43.5
2.7
10.3
3.8
#
#
#
These number are based on a 10-year history. I do not believe that Bank of America will revert to its
mean in the years to come as the bank and the industry as a whole were profundly impacted by the
financial crisis. I computed the 1-year target multiples with the assumption that the ratios would keep
moving up from their low point, and that they would gain twice what they already recovered. This gave
me the following formula:
Target = Current + (Current - Low)x2
I expect a negative value for each of the three ratios derived from earnings (P/E, P/EBITDA, and P/CF). As
a result, I decided to not use them in the valuation process. I believe that P/S and P/B are better
guidelines to value Bank of America. For P/S, I used the 2012 revenue estimates from the DCF model
section above. To determine the book value of Bank of America, I took the total assets as of the third
quarter 2011, substracted goodwill, intangible and liabilities, and added my net income estimates for
2011 and 2012. The multiple valuation provides a final valuation range between $10.22 and $10.60 per
share, which is in line with the $11.31 per share obtained through the DCF analysis. It reinforces my
opinion that the stock is undervalued. As a result, I adopted a with a 1-year price target of $10.50.
Page 13 of 20
November 28, 2011
Industry Multiples
Bank of America is trading at lower multiples than its main competitors. This makes sense when looking
at the company’s profitability, but it does not reflect Bank of America’s revenue-generating potential.
Bank of
America
J.P.
Morgan
Citi
Wells
Fargo
P/Forward E
5.8
6.3
5.9
7.7
P/S
.6
1.1
.9
1.5
P/B
.3
.6
0.4
1.0
P/EBITDA
.89
3.12
1.74
4.33
P/CF
3.8
4.9
5.3
7.4
Technical Analysis
Bollinger Bands
The lower Bollinger band is usually considered a zone of support and the higher band a zone of
resistance. Technical traders prefer to buy when the stock gets closer to the lower band and sell when it
reaches the higher band (green marks).
If he stocks breaks above its resistance level, a bump in prices can be expected. Similarly, a sharp fall can
be expected if it breaks below the lower band (red mark).
I did not use technical analysis to determine the long-term potential of Bank of America, but I believe it
can be used to decide when to invest in the stock. The stock is currently close to the lower band, which
means that we are in a favorable period for an investment.
Page 14 of 20
November 28, 2011
Conclusion
I believe that Bank of America’s stock could double its price in the coming year. My one year price target
is $10.50. That valuation implies considerable upside for stock owners, outweighing the risks faced by
the bank. As a consequence, I give the stock a BUY recommendation. Finally, I would like to stress that
this stock is more appropriate for investors who are looking for a high risk/return couple and is probably
not suitable for conservative or risk-averse investors.
Investment Thesis
•
•
•
•
•
•
•
One-year price target of $10.50 (100% upside)
DCF valuation at $11.31 per share (115% upside)
Multiple valuation range of $10.22 to $10.60 per share (95% to 102% upside)
Project New BAC with planned cost savings of $5 billion a year
Default rates falling on both mortgage and credit-card portfolios
Investment by value investor Berkshire Hathaway
Technical Analysis showing stock trading near the lower Bollinger band
Risks
•
•
•
•
Revenues are put at risk by the restructuration and the slow economic recovery.
The Eurozone crisis could keep weighing on the market in the next year and prevent Bank of America
from reaching its target price.
The bank is involved in many lawsuits with claims totaling almost $100 billion.
The implementation of Dodd-Frank could further depress revenues and also increase the cost of
doing business for the bank.
Disclaimer: The opinions and information contained herein have been obtained or derived from sources believed to be reliable, but the Fisher
College of Business makes no representation as to their timeliness, accuracy or completeness or for their fitness for any particular purpose. This
report is not an offer to sell or a solicitation of an offer to buy any security. The information and material presented in this report are for general
information only and do not specifically address individual investment objectives, financial situations or the particular needs of any specific
person who may receive this report. Investing in any security or investment strategies discussed may not be suitable for you and it is
recommended that you consult an independent investment advisor. Nothing in this report constitutes individual investment, legal or tax advice.
Page 15 of 20
November 28, 2011
Exhibit 1: Lawsuits Filed Against Bank of America and its Competitors
Page 16 of 20
November 28, 2011
Exhibit 2: Bank of America’s Capital Ratios
Page 17 of 20
$
$
435
Page 18 of 20
14.2
30.7
628.7
648.4
10,134
5.25
11.31
115%
Shares Outstanding (millions)
Current Price
Implied equity value/share
Upside/(Downside) to DCF
45,046
69,607
114,652
4.02%
Current P/E
Projected P/E
Current EV/EBT
Projected EV/EBT
NPV of Cash Flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
52.5
113.1
1,352.8
1,395.2
39%
61%
100%
-127.4%
1,600
(586)
1,600
2,140
Preferred stock dividends
Free Cash Flow
% Grow th
1,014
3,740
Net Income
30.0%
(623)
-20.0%
Income tax expense (benefit)
Tax Rate
1.7%
1,449
-3.0%
73,359
30.00%
11,747
-5.0%
86,555
-5.0%
47,398
-5.0%
39,157
2012E
3.4%
3,117
75,628
30.00%
12,366
91,111
49,892
41,218
2011E
EBT margin
Income (loss) before taxes
Grow th in noninterest income
Total noninterest expense
Provision for credit losses as a % of net interest income
Provision for credit losses
% Grow th
Revenue
% Grow th
Noninterest income
% Grow th
Net interest income, FTE basis
Year
Analyst: Edouard Sevil
Date: 11/29/2011
(Dollars in millions, except per share information; shares in thousands)
Bank of America
15.6
33.6
402.1
414.7
-409.2%
1,600
1,812
3,412
30.0%
1,462
5.6%
4,874
-2.0%
71,892
25.00%
9,789
0.0%
86,555
0.0%
47,398
0.0%
39,157
2013E
130.3%
1,600
4,172
5,772
30.0%
2,474
9.3%
8,246
-2.0%
70,454
24.0%
9,586
2.0%
88,286
2.0%
48,346
2.0%
39,941
2014E
Debt
Cash
Cash/share
Total Assets
Debt/Assets
40.6%
1,600
5,866
7,466
30.0%
3,200
11.7%
10,666
0.5%
70,807
23.0%
9,462
3.0%
90,935
3.0%
49,796
3.0%
41,139
2015E
Terminal Discount Rate
Terminal FCF Growth
$ 1,989,376
$
82,865
$
8.18
$ 2,219,628
89.6%
39.8%
1,600
8,199
9,799
30.0%
4,200
14.8%
13,999
0.5%
71,161
22.0%
9,413
4.0%
94,572
4.0%
51,788
4.0%
42,784
2016E
13.0%
2.5%
37.1%
1,600
11,245
12,845
30.0%
5,505
18.5%
18,351
0.5%
71,517
21.0%
9,434
5.0%
99,301
5.0%
54,377
5.0%
44,924
2017E
34.3%
1,600
15,103
16,703
30.0%
7,158
22.7%
23,861
0.5%
71,874
20.0%
9,524
6.0%
105,259
6.0%
57,640
6.0%
47,619
2018E
9.2
58.1
Terminal P/E
Terminal EV/EBITDA
10.24%
Free Cash Yield
10.7%
1,600
24,205
25,805
30.0%
11,059
31.1%
36,864
0.5%
72,958
16.0%
8,570
3.0%
118,391
3.0%
64,831
3.0%
53,560
2021E
236,285
17.8%
1,600
21,856
23,456
30.0%
10,052
29.2%
33,508
0.5%
72,595
17.0%
8,840
4.0%
114,943
4.0%
62,943
4.0%
52,000
2020E
Terminal Value
22.8%
1,600
18,552
20,152
30.0%
8,637
26.0%
28,789
0.5%
72,233
19.0%
9,500
5.0%
110,522
5.0%
60,522
5.0%
50,000
2019E
November 28, 2011
Exhibit 3: DCF Model
10.0%
10.5%
11.0%
11.5%
12.0%
12.5%
13.0%
13.5%
14.0%
14.5%
15.0%
0.0%
$14.59
$13.59
$12.69
$11.88
$11.14
$10.47
$9.86
$9.30
$8.78
$8.31
$7.87
0.5%
$15.12
$14.06
$13.10
$12.23
$11.45
$10.75
$10.10
$9.51
$8.97
$8.48
$8.02
1.0%
$15.72
$14.57
$13.54
$12.62
$11.79
$11.05
$10.37
$9.75
$9.18
$8.67
$8.19
1.5%
$16.38
$15.14
$14.03
$13.05
$12.17
$11.37
$10.66
$10.00
$9.41
$8.87
$8.37
Terminal FCF Growth
2.0%
2.5%
3.0%
$17.12
$17.97
$18.93
$15.77
$16.49
$17.30
$14.58
$15.19
$15.88
$13.52
$14.05
$14.63
$12.58
$13.03
$13.53
$11.73
$12.13
$12.56
$10.97
$11.31
$11.69
$10.28
$10.58
$10.91
$9.65
$9.92
$10.21
$9.08
$9.32
$9.58
$8.56
$8.77
$9.00
3.5%
$20.05
$18.22
$16.65
$15.29
$14.10
$13.04
$12.11
$11.28
$10.53
$9.85
$9.24
4.0%
$21.34
$19.29
$17.54
$16.04
$14.73
$13.59
$12.58
$11.68
$10.88
$10.16
$9.51
4.5%
$22.88
$20.54
$18.57
$16.89
$15.45
$14.19
$13.10
$12.13
$11.27
$10.50
$9.81
5.0%
$24.72
$22.01
$19.77
$17.88
$16.27
$14.88
$13.68
$12.63
$11.69
$10.87
$10.13
November 28, 2011
Exhibit 4: DCF Sensitivity analysis
Page 19 of 20
Terminal Discount Rate
November 28, 2011
Exhibit 5: Alternative Analyst Targets
Exhibit 6: Analyst Bio
Edouard Sevil grew up in France where he graduated from Audencia Nantes School of Management. He
started his career in Paris as a Junior Risk Analyst working on Project Finance deals for Credit Agricole CIB
before joining a team of Private Bankers at BNP Paribas.
Edouard is currently a Full-Time MBA student at the Ohio State University, Fisher College of Business. He
joined the OSU Student Investment Management program in fall 2011. The SIM program allows Fisher
students to get a hands-on experience of investing by managing a $10.5 million equity portfolio.
Edouard is the Vice-President of Investment Management for Fisher’s MBA Finance Association and an
elected Student Representative on the Fisher Graduate Student Association Board. He was on the team
representing the Fisher College of Business in the CNBC MBA Face-Off Competition.
Page 20 of 20