Is Bank of America Getting More Credit Than It Deserves?

Wall Street is usually a forward-looking sort of place, but investors may be taking it a bit far with Bank of America (NYSE: BAC  ) .

While the bank does indeed have substantial scope for improving its costs and taking advantage of higher rates, current valuations seem to factor in almost no risk that the bank won't succeed -- a rather high amount of faith in a company that really hasn't done a lot to earn it yet.

Bank of America definitely has more to gain from higher rates than Citigroup, JPMorgan, Wells Fargo, or U.S. Bancorp, but investors have to assume that they will manage to cut costs and maintain credit discipline should they arrive. With that, JPMorgan and Wells Fargo continue to offer more upside in a "base case" scenario, but if everything goes right, Bank of America could continue to tick higher.

Solid as a rock
To its credit, Bank of America did deliver a pretty solid set of results relative to expectations.

Revenue rose 2% sequentially, with net interest income up about 5% -- well ahead of the barely positive growth of JPMorgan or Wells Fargo. Although B of A saw slower deposit growth than these two rivals, net interest margin improved both annually and sequentially. The bank's fee income wasn't bad; like JPMorgan and Wells Fargo, B of A saw a big decline in mortgage banking, but trading and investment banking held up better (albeit from a lower base).

Despite the bank's efficiency ratio still hovering in the vicinity of 70% (much higher than its peers), expenses ticked lower on the back of the bank's New BAC initiative. All together, core pre-provision profits were up about 30% from the year-ago period, and 14% from the prior quarter.

Where's the growth?
One disappointment was the loan growth at Bank of America. Neither JPMorgan nor Wells Fargo had a quarter to brag about, but the 1% sequential decline at Bank of America was surprising given the comments from other lenders about improving loan demand. While credit loans saw growth both in and out of the U.S., all of the other consumer loan categories were down, and C&I lending was up just 1%. While there weren't big growth numbers posted, credit quality managed to improve.

Where to from here?
Bank of America has lost a lot of share in the mortgage market over the past three or four years, with Wells Fargo and JPMorgan taking up some of that business. Even so, Bank of America holds about 12% of the retail deposits in this country.

This is also a very asset-sensitive bank. Looking through the company's SEC filings, a 100 basis point parallel rate move would drive Bank of America's pre-tax 2014 earnings about 14% higher. That's roughly double the leverage JPMorgan or Citi would have to the same move, and more than double the leverage at Wells Fargo.

Although rising rates would likely lead to some increase in defaults (particularly in commercial), rates usually head higher when the economy is stronger on balance.

Investors should still be looking for better expense leverage from Bank of America. The bank's cost structure is still inflated, and while the stock has more than tripled since its late 2011 lows, the company's tangible book value is up only 4% since the first quarter of 2011, and return on tangible assets has remained quite weak.

The bottom line
There is definitely significant scope for Bank of America to improve its operating performance and results, but investors are already baking a lot of that into the valuation. More progress with profitability in 2014 would support a higher book value-based multiple. If the bank can consistently deliver double-digit returns on its equity base, the stock may still be a bargain.

That said, JPMorgan and Wells Fargo may still be better buys than Bank of America. Investors everywhere want to like the Bank of America recovery story, and if the bank can stay out of trouble, there's definitely still more room for value-generating improvement.

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