Q4 Preview: Will BofA (BAC) Beat? It's Worth a 'GSE'

Bank of America Corporation (NYSE: BAC) is higher today ahead of their fourth quarter earnings release, expected out before the market opens tomorrow, January 21. Shares are up 1.2% in afternoon trading.

BofA is expected to report EPS of $0.14 with revs of $24.87 billion. Last quarter, the New York, NY-based financial firm reported EPS of $0.27, ex-items, with revs of $27.0 billion, mixed to the Street consensus. In Q409, BAC produced a loss of $0.60 per share on revs of $25.08 billion, both missing views.

Shares gained 13% through the quarter to $28.23 at the end of December. The stock is down 0.9% from the end of last quarter, and ended 2010 about 8% lower.

A simple valuation puts Bank of America with a forward P/E of 9.8x FY11 EPS estimates, compared to 9.6x for Goldman Sachs (NYSE: GS), 9.6x at J.P. Morgan Chase (NYSE: JPM), and 8.7x for Citigroup (NYSE: C).

Data from Bloomberg has 21 analysts with a Buy on BAC, 13 with a hold, and none suggesting to Sell. The analyst price target average is $18, with a high of $26 and low of $14.

Summary

• Goldman Sachs makes the statement: "Last week, BAC reached two agreements with the GSEs that reduce rep and warranty exposure on CFC-originated loans (75% of total originations). As part of the agreements, BAC paid $2.8 billion in total to the GSEs to substantially eliminate its exposure to FRE put-backs on CFC-originated loans ($127 bn outstanding), as well as to reduce the pipeline of FNM loans (from $5.2bn to $2.1bn) and consequently provisioned $3.0 billion to cover the cost of the agreements as well as any remaining GSE exposure. BAC noted that the remaining GSE reserve should be sufficient to cover all additional GSE rep and warranty losses. If this is the case, we estimate $9.8 billion in lifetime GSE losses for BAC, which translates into 88 bp loss severity on total mortgages sold to the GSEs from 2005 to 2008."
  
  
• J.P. Morgan notes that the GSE settlement of $2.8 billion related to Countrywide (CFC) loans adds to $3.5 billion of losses realized through the end of 2010, for a cumulative loss of $6.3 billion on GSE-related loans. JPM continues: "Overall losses are likely to be higher with some additional losses on FNM and on non-CFC loans. Additional FNM losses could add $2-6 bil and non-CFC originations could add another $700 mil, which would bring cumulative 2004-2008 vintage GSE losses to $9-12 bil, above our estimate of $6.3 bil (which covered a little shorter 2005-2007 period)."
  
  JPM notes that the settlement doesn't include non-CFC legacy entities, meaning the bank will still have $2.7 billion in outstanding GSE claims of which $832 million relates to missing documents which are in the process of being cured.
  
  JPM is looking for an EPS of $0.16. They have an Overweight rating on the shares, with a price target of $21.
  
  
• Wells Fargo is expecting a Q410 loss of $0.07 per share. Wells notes that BofA "will take approximately $3.0B in reserve build for representations & warranties (R&W) vs. our prior $0.8B estimate ($0.14) and a $2.0B non-cash, non-taxable charge for goodwill impairment in its Home Lending and Insurance unit ($0.20)."
  
  On the cost of settlement, Wells says, "Despite relatively similar R&W loss experience through 2010, adjusting for the agreement BAC's losses will total 106 bps of the loans CFC sold to Freddie Mac, compared to just 39 bps to date (with more to come) for Fannie Mae. We believe BAC was willing to pay a higher price to complete a broader agreement. Also, CFC has sold 74% of its GSE loans to Fannie Mae, likely giving the latter a stronger negotiating stance...we estimate future losses from Fannie Mae (which inked a less comprehensive agreement) could total $2.9B. We estimate BAC's GSE-related reserves will more than cover this future exposure at FYE 2010."
  
  "Non-GSE exposures remain but appear manageable." Wells has a $10 - $20 valuation range on the stock, and an Outperform rating.
  
  
• Deutsche Bank says that positives for the bank include: Good leverage to an economic recovery, low valuation, and collection of good franchises. BofA has a loan mix that provides good leverage to a better-than-expected macro environment, notably in labor and housing. Consumer charge-offs are down about 35% since their peak in Q110. BofA also benefits from their collection of good franchises: "#1 in U.S. commercial and corporate banking, #2 in global investment banking (vs. #3 in 2009), #1 in retail banking, #1 in debit cards, #2 in credit card, #1 in investment services, and is the #1 mortgage servicer. BAC also has a strong wealth management/brokerage franchise."
  
  Negatives from DB include: Mortgage-related risks, lower potential earnings power than expected, and low capital under Basel 3. DB thinks mortgage-related costs will amount to $10 billion. Private label exposure remains a wildcard, possibly resulting in another $7 - $15 billion of losses. "Separately, 45% of BAC’s home equity and 35-40% of its residential mortgages have little or no equity behind them—exposing BAC to a double dip in housing, if one were to occur." Moving forward, earnings may see some pressure from a shrinking balance sheet. Management's $132 billion in runoff loans could easily balloon to $200 billion. An additional $100 - $200 billion reduction to BofA's discretionary portfolio is possible over time.
  
  With Basel 3: "estimate Tier 1 common to rise to 5% by year end 2010 (including the BLK sale and the $3b mortgage repurchase charge in 4Q10)—lower than our estimate of just under 8% for banks overall. We also believe capital levels may not build as quickly over time vs. at other banks, given higher mortgage-related risks and regulatory drags could offset the benefit from earnings, reserve drawdowns, and de-risking. We estimate Tier 1 common to be about 8% by the end of 2012 vs. 10% for banks overall."
  
  
• Finally, briefly, Keefe, Bruyette & Woods notes that "BAC continues to have both GSE and private-label exposures, which will likely continue to drive future rep-and-warranty losses, in our opinion." They are looking for an EPS of $0.04.

Bank of America Corp. is expected to release their Q410 earnings on Friday, January 21, 2011, at approximately 7:00am EST. Stay tuned to StreetInsider.com's EPS Central section to see our analysis of the highly-anticipated quarterly results withi0 n seconds of their release.

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