Risk, Reward, Balance BofA

We are maintaining our long-term ‘Neutral’ recommendation on Bank of America Corporation (BAC - Analyst Report) to reflect the company’s improving credit quality and various restructuring measures undertaken. Yet, we expect revenue headwinds, incessant litigations and various issues related to the regulatory changes to continue to impact the near-term results.

Further, BofA reported break-even third quarter earnings compared with Zacks Consensus Estimate loss. Results benefited from substantially lower provision for credit losses and almost stable operating expenses. On the flip side was the lower top line.

Management remains focused on managing capital levels efficiently. To remain afloat, BofA has been trying to realign its balance sheet in accordance with the regulatory changes post the meltdown. In fact, over the last two years, BofA has completed the divestiture/closure of more than 20 non-core assets to strengthen its capital position so that it can focus on its core operations.

Moreover, BofA has made considerable progress in strengthening its balance sheet, which reflects in its improved capital ratios and successful clearance of the stress test in March 2012. Now, we anticipate that the company would aspire for dividend hike and share repurchase next year, when it will submit new capital plan for the next round of stress test.

Last year, BofA launched a company-wide expense reduction initiative – Project New BAC – with the goal of bringing down the expenses. The implementation of Phase 1 of the program began in October 2011 with an aim to reduce costs by approximately $5 billion per year by 2014. With the completion of Phase 2, the company expects a total of $8 billion in annualized cost savings by mid-2015 from this initiative.

However, we remain concerned about 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 will remain elevated in the near term. In June 2012, Moody’s Investor Services, the rating arm of Moody’s Corp. (MCO - Analyst Report), downgraded the company’s ratings by a notch on the back of a weak economic environment.

In addition, the financial reform law is expected to have a lingering effect on BofA’s profitability, resulting in higher costs, fee reductions and restrictions. In the mid term, stringent capital requirement is expected to somewhat reduce the company’s flexibility with respect to its business investments.

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