Shares of Bank of America (BAC -0.97%) are soaring today after an analyst at Morgan Stanley raised her price target on the nation's second largest bank by assets. While Betsy Graseck had previously issued a $13 target, in a note to clients this morning, she raised it to $16, equating to a 37% upgrade.
"You don't get a lot of second chances in life and so we are taking advantage of this one," Graseck wrote, according to TheStreet.com. "[Bank of America] is about to deliver on a significant expense reduction over the next several quarters, which should fall to the bottom line and boost EPS. Also, we expect [the bank] will be largely through significant litigation risk by [the end of] 2013."
The news comes as a welcome relief to many Bank of America investors. The Charlotte-based lender has seen its shares plummet after announcing first-quarter earnings at the beginning of last week. For the three months ended March 31, it earned $0.20 per share compared to the consensus estimate of $0.22 per share.
In light of the post-earnings fall, it'd be tempting to conclude that Bank of America had a horrible quarter. But as I've noted before, I couldn't disagree with this assessment more.
There are two factors holding Bank of America back. The first is litigation risk. Since the financial crisis, the bank has paid tens of billions of dollars to settle lawsuits related principally to the origination of faulty mortgages by Countrywide Financial. Of the remaining cases, the biggest outlier is a collection of securities fraud actions before a federal judge in California. While I had previously estimated that the damages from these cases could range anywhere from $5 billion to $15 billion, we learned in Bank of America's earnings release that the figure will be much smaller thanks to a $500 million settlement that resolves upwards of 80% of the outstanding securities fraud cases.
The second factor is costs. If you dig into Bank of America's financial results, you'd see that the principal operational culprit behind the bank's uninspiring profitability is its mortgage-servicing division. Thanks to higher regulatory requirements and lower quality mortgages, Bank of America has found itself throwing money in this direction. Thus, the faster it can shrink the affiliated operations, the better. And that's exactly what Bank of America has done, reducing the size of its mortgage-servicing portfolio by nearly 30% on a year-over-year basis.
At the end of the day, in turn, while I don't usually pay much attention to analyst upgrades and/or downgrades, I think Graseck may be onto something, here.
