Bank of America to Reap Mortgage Windfall: Analyst

Bank of America branch, New York City.
Oliver Quillia for
Bank of America branch, New York City.

Bank of America andSunTrust should see a “sizeable earnings benefit” from a recovering housing market, according to JPMorgan Chase analyst Vivek Juneja.

The analyst on Thursday said that “with home prices rising for the past few months,” he expects major cost savings for the lenders, with reduced net loan charge-offs (NCOs), lower expenses related to repossessed real estate, and a decline in “other credit related expenses, such as collections and servicing.”

Juneja said that for combined residential loan losses, repossessed real estate expenses, and other credit expenses, “Bank of America and SunTrust are at the high end at 138 percent and 95 percent of 2Q12 EPS, respectively,” and that a “five to 20 percent further reduction in residential mortgage related NCOs and [repossessed real estate] expenses above expectations could add 3 to 7 percent to 2013 EPS for Bank of America and SunTrust.”

“In addition, 10 percent reduction in other credit related expenses could add 2 to 5 percent to 2013 EPS,” he said. These expenses are particularly high for Bank of America, “with $2.5 billion of expenses led by its $1.2 trillion servicing portfolio with 13.5 percent delinquency ratio,” and “recovery in the housing market should reduce problem loans faster (and also staff).”

While banks are continuing to see a greatly elevated level of mortgage loan refinancing, mainly because of the Home Affordable Refinance Program, or HARP, which was expanded by President Barack Obamaexpanded early this year, to allow qualified borrowers with mortgages held by Fannie Mae or Freddie Mac to refinance their entire loan balance, at today’s low rates, no matter how far “underwater” the underlying property might be, following the collapse of housing values, Juneja said that home “purchase mortgage originations should rise with housing market recovery and continued increase in the cost of renting.”

An increase in home purchase loan originations “will likely be offset by decline in refi volumes over time,” he said, but “Wells Fargo should be the biggest beneficiary with its large 40 percent market share of the purchase market and as the only bank in our [bank coverage] group with a substantially larger share of the purchase market versus refis.” Under HARP 2.0, there is no loan-to-value ratio limit, where a lender originating a traditional first-lien mortgage loan would typically require the borrower to obtain costly private mortgage insurance, to protect the lender, if the loan is for more than 80 percent of the underlying home’s market value.

Both Bank of America and SunTrust face large mortgage repurchase demands from mortgage-backed securities investors, with Bank of America seeing total mortgage putback claims rising 41 percent just in the second quarter, to $22.7 billion as of June 30.

Bank of America’s shares closed at $7.95 Wednesday, returning 44 percent year-to-date, following a 58 percent decline during 2011.

The shares trade for 0.6 times tangible book value, and for nine times the consensus 2013 earnings estimate of 91 cents a share, among analysts polled by Thomson Reuters. The consensus 2012 EPS estimate is 55 cents.

Juneja rates Bank of America “overweight,” with a price target of $11.50.

Shares of SunTrust closed at $25.45 Wednesday, returning 31 percent year-to-date, following a 40 percent decline during 2011.

The shares trade for 1.1 times tangible book value, and for 10 times the consensus 2012 EPS estimate of $2.61. The consensus 2012 EPS estimate is two dollars.

SunTrust on Aug. 22 announced that theFederal Reserve had approved the company’s revised capital plan, although the company “did not request an increase in its common stock dividend or the repurchase of shares of its common stock in 2012.” The company’s initial 2012 capital plan was partially rejected by the Fed back in March, with the regulator agreeing to the company's plan to redeem trust preferred shares, but objecting to any common share buybacks or an increase in the dividend on common shares.

Juneja on Thursday upgraded SunTrust to an “overweight” rating from an “equal weight” rating, while raising his price target for the shares to $31.50 from $29, “reflecting our increased EPS forecast.”

The analyst raised his 2012 earnings estimate for SunTrust by four cents to $2.02, and his 2013 EPS estimate by eight cents to $2.60.

Juneja said that the Atlanta lender “has had losses and expense drag more akin to the money center banks from its mortgage related businesses along many fronts,” and that the “drag from credit/servicing related expenses has kept SunTrust’s efficiency ratio very high and offset the benefit from its cost restructuring program.”

The analyst said that SunTrust’s “valuation is attractive at 1.0x tangible book, which is below peers, and that "2013 does not represent normalized earnings and the large drag from housing related costs should be a greater benefit to earnings than peers beyond 2013.”

—By’s Philip van Doorn

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