A couple of weeks ago, I wrote two articles about the CCAR portion of Federal Reserve's stress tests for the big banks. The results were relatively good for my only big bank holding at the time, Wells Fargo (NYSE:WFC). Wells Fargo stock reacted especially well to the results when compared to the other banking giants.
On the other hand, Bank of America (NYSE:BAC) only passed the stress test after first modifying original capital plans and resubmitting in the days prior to the public release of the results. Bank of America's officially released capital plan included a quarterly dividend increase from $0.01 to $0.05 and a $4 billion share buyback plan. At the end of the week last week, B of A's stock closed down just over 7% from where it closed on the day the CCAR results were released just over a month ago. Then on Monday of last week, Bank of America dropped a bombshell on its shareholders by announcing that it had made a $4 billion accounting error in it's CCAR proposal and would be suspending its dividend and buyback plan and resubmitting a revised capital plan to the Fed for approval.
Just a minor oversight, right?
In Bank of America's defense, we've all been there before, right?
You remember that time you left $4 billion in your pants pocket when you dropped them off at the cleaners, and you know the girl that works at the counter will just keep it when she finds it... Or you are doing your taxes, and you end up with a yearly income of $4 billion because of a typo where you unwittingly added 6 extra zeros. Or the professional appraisal that you got for your house is about $4 billion less than you anticipated. I mean come on, it has an in-ground pool for Pete's sake!
All kidding aside, my first reaction to the Bank of America news last week was a head shake and a grin. There will always be a soft spot in my heart for Bank of America for two reasons. First, it is my personal bank. Second, I have made more money from trading Bank of America stock in my life than any other stock by a very wide margin. When I saw the stock had plummeted on the news to around $15 per share (about a 12% drop from a month ago), I immediately began digging for details.
Mr. Market is at it again
As is often the case with bad news, the more I learned about the situation, the more it became apparent to me that the 6% one-day sell-off was an overreaction. Of course $4 billion seems like an ungodly amount of money to most of us, but the sad truth is that it is not very much money to Bank of America.
Even with the strict capital requirements in place for the big banks, the Fed was prepared to allow Bank of America to return over $4 billion to its shareholders in the form of dividends and buybacks. I assume that means that the worst-case scenario for shareholders is no dividend hike in 2014 and no buybacks. But since this "accounting error" is (supposedly) a one-time deal, the future of the company remains on exactly the same track for 2015 and beyond.
I wondered if I was just missing something in the details until I read that Morgan Stanley analysts Betsy Graseck and Michael Cyprys pretty much agreed with my assessment of the situation. In fact, the $4 billion didn't affect Graseck and Cyprys' 2014 EPS forecast for Bank of America by a single cent. Based on the assumption that the buybacks won't be happening at all this year, they lowered their 2015 EPS forecast by a whopping 1.3%, about a fifth of the size of the price drop Bank of America's stock endured on the day news of the error hit. So yeah, I'd call that an overreaction.
A smart response
As a result, I decided Monday to take a relatively large position on Bank of America. No shareholders ever want to hear the words "accounting error" and "suspended dividend," so the market got spooked.
Fear is one of the strongest driving forces in the stock market, and overreactions such as this one happen rather frequently. At $15.00 a share, Bank of America's forward P/E ratio dropped back below 10 for the first time in a while, not to mention the fact that the price-to-book ratio is now around 0.75. Those numbers are ridiculously low and indicate that investors are pricing in far more bad news than has actually occurred here.
The market sentiment toward Bank of America is understandably pretty bad right now, and the uncertainty revolving around the resubmission of the capital plan might continue to weigh down the stock in the coming weeks -- but, like it or not, these megabanks tend to come out on top in the long run.
Wayne Duggan owns shares of Bank of America and Wells Fargo. The Motley Fool recommends Bank of America, Goldman Sachs, and Wells Fargo. The Motley Fool owns shares of Bank of America and Wells Fargo and has the following options: short June 2014 $50 calls on Wells Fargo and short June 2014 $48 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.