BofA Reiterated at Neutral

We are maintaining a long-term ‘Neutral’ recommendation on Bank of America Corporation (BAC - Analyst Report). The affirmation is based on improving credit quality and various measures including realignment of the balance sheet in accordance with regulatory changes as well as launching expense reduction initiatives that vouch for better prospects going forward.

Further, BofA’s second quarter earnings were marginally better than the Zacks Consensus Estimate and reflect improved non-interest income, a slowdown in provision for credit losses and lower non-interest expense. However, net interest income fell due to a weak interest rate environment.

Moreover, BofA has made considerable progress in strengthening its balance sheet as reflected by improved capital ratios and successful clearance of the stress test in March 2012. In fact, over the last two years, the company has completed the divestiture of more than 20 non-core assets to strengthen its capital position to meet the new international capital standards and focus on its core operations.

In 2011, BofA launched a company-wide expense reduction initiative – Project New BAC – with the goal of bringing down expenses. Implementation of Phase 1 of the program began in October 2011 in order to reduce expenses by approximately $5 billion per year by 2014. Moreover, with the completion of Phase 2 evaluations, the company expects further $3 billion in annualized cost savings by mid-2015.

However, we remain concerned regarding BofA’s elevated cost structure. Though operating expenses started declining in the recent quarters due to the implementation of Project New BAC, we believe that as the company is in the process of addressing legacy issues and continues to invest in its franchise, operating expenses are expected to remain elevated in the near term.

Moreover, BofA has failed to complete a large number of mortgage modifications under the $25 billion settlement deal. This was stated in a report presented by the official, scrutinizing the foreclosure settlement agreement between the U.S. government and some of the nation’s largest banks. Under the settlement deal, the five banking biggies – BofA, Citigroup Inc. (C - Analyst Report), JPMorgan Chase & Co. (JPM - Analyst Report), Wells Fargo & Company (WFC - Analyst Report) and Ally Financial Inc. – are required to provide around $20 billion in an effort to bring relief to homeowners on the verge of eviction. However, the company is falling behind in the mortgage modification process as it is consuming more time to underwrite the modified loans.

In June 2012, Moody’s Investor Services, the ratings arm of Moody's Corp. (MCO - Analyst Report), downgraded BofA’s ratings by a notch on the back of an overall weak economic environment and the fact that the earlier ratings were not reflective of the true nature of the challenges faced by the company. Further, the agency placed the company in the third category (the weakest) with the standalone credit assessment of ‘baa3’ reflecting the company’s lack of stable capital cushions to survive another financial downturn. The ratings downgrade is expected to escalate the already high funding cost of the company.

BofA currently retains a Zacks #3 Rank, which translates into a short-term Hold rating.