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What Next for Bank of America?

Yet 2008 proved that Wall Street was not just splattered by blood but booby trapped with carcasses, gore and rotting entrails. After all, (presumably) smart money sovereign investors like Singapore’s Temasek, Abu Dhabi’s ADIA, China’s CIC, Norway’s Oil Fund and Kuwait’s KIA lost 60 to 80 per cent of their money betting on Citigroup, Morgan Stanley, Merrill Lynch and UBS when their CEO’s first began to roam the back allays of the Euromarkets last winter with their capital raising begging bowls.

There are many bloody fingers in town among those who tried to catch falling knives as diverse as property shares listed on the DFM, a certain container part and shipping company listed on NASDAQ Dubai (ex-DIFX) and Himalayan hoards of steel (the wannabe King Midas of the Textile Market tried to out-Mittal Lakshmi Mittal!). So it appears downright weird for me to muse about Bank of America (symbol on the Big Board BAC), an icon of a global business gutted by the credit crunch, consumer loan defaults and the nuclear winter in home prices.

It is surely premature to sniff for money making opportunities in America’s ultimate retail bank? Not way. Stock markets discount the future, not the past. While BAC has plummeted from 45 to 13, I cannot really table pound a bottom as it is impossible to model the bank amid such seismic shifts in the credit wasteland. Still, fee foo fum, I smell the blood of a double bagger in the boonie bankers of Charlotte, North Carolina. But where and when? Not exactly elementary, my dear Watson.

One, if ever there was a transformation deal on Wall Street, the $50 billion all stock Merrill-BAC is it. At one stroke, John Thain and Ken Lewis have created a wealth management colossus, with 20,000 brokers and eight million affluent potential accounts. Bank Am also bought US Trust from Charles Schwab. It is now the largest wealth manager in the world, since Merrill’s crown jewel Global Private Clients division boasted 16,000 brokers. Wealth management is also now one fifth of the bottom line in America’s largest bank. This is a game changer event in global finance, ignored by the stock market at a time when grizzlies rule the roost and the Thundering Herd has stampeded off the CDO/subprime cliff. But, mark my words, Merrill will be the high octane fuel for a quantum increase in BAC’s valuation. Only not now.

Two, I am under no illusions that the credit cycle will turn in 2009. Au contraire, the property crashes I witnessed in Hong Kong (1997), California and New York (1991), New England (1992), Texas and the Gulf (mid 1980’s) in my own life convinces me that real estate prices keep falling for at least three years after their peak as inventory is bloated, foreclosures spike up, developers and go go financiers go to money heaven, speculators are wiped out. A financial neutron bomb hits banking balance sheets when exposure to real estate is even 5 per cent of GDP, as Spain, Ireland and the UK demonstrate. So I fully expect prime mortgages, consumer loan and commercial property defaults to rise in 2009, even next year. However, Mr Market has discounted Armageddon. That is the reason BAC trades at a shocking 4 times its normal forward earnings of $3 a share. Cheap? Who knows? Nothing can be more painful than kissing a Cinderella who turns out to be a value trap ugly stepsister. But BAC is cheap, dirt cheap on any same metric.

Three, BAC has a stellar record in integrating its acquisitions under Ken Lewis and his predecessor High McColl, who built American’s largest bank from the obscure NCNB in the 1980’s. After all, Lewis managed to snare and digest Fleet Boston, MBNA, Chicago’s La Salle Bank, Countrywide Financial, US Trust and now Merrill Lynch. Brand, scale and cost cutting is the name of the toughest game in high finance. BAC has announced 35,000 job cuts. Lewis is thankfully not exposed to the weakest areas of consumer finance, such as auto leasing and subprime. He has also won huge political brownie points with the Fed and the US Treasury when he came out to white knight Countrywide and Merrill. The plebes of Main Street bailout the plutocrats of Wall Street. Hallelujah, surely this is a financial fairy tale in the Age of Obama, the ultimate Main Street champion. Uncle Sam put $25 billion into BAC under TARP and BAC raised another $10 billion in a secondary share offering, giving it a lovely Basle Tier One capital.

Four, BAC is perfectly positioned in New Age finance, with its $875 billion in customer deposits, the lowest cost, stablest funding for a commercial bank. Since BAC cannot really do a big banking deal in the US (it has reached the limit of ten per cent in Federal insured deposits), I am convinced Lewis will hunt bellwether retail trophy banks abroad, particularly in Asia, the world’s future economic growth engine. So I expect the 8 per cent BAC dividend to be a short term gift. Global growth could be its next frontier, particularly since its traditional rival Citigroup is on its knees. The sale of its China Construction Bank stake alone is good for a $3-4 billion jackpot, even tough Lewis just doubled up.

Five, my biggest worry is investment banking. BAC never succeeded in its organic, build not buy strategy, other then in syndicated loans, where its market share is only exceeded by J.P. Morgan Chase. This is a culture clash minefield, as the Citi-Solomon, Amex-Lehman, Dresdner-Kleinwort and Credit Suisse – DLJ disasters prove. Lewis wants to be the Walmart of banking to his 60 million consumer clients. But Walmart does not coexist with Harrods even though investment banking is in Merde City right now. Still, in a strategic sense, Merrill’s I-bank platform finally gives BAC a universal banking model, even if the business is not a rainmaker but a financial black hole for now.

The financial markets are deeply sceptical about BAC’s proximate future. The credit defaults swaps and share prices have plunged by a third since the TARP capital injection and Merrill deals. Lovely. It is too late to jump on a stock when even Numero Uno Dumbos aka analysts of Wall Street salivate over its prospects. However, I can only see a trillion dollar deposit base at BAC, as flight to quality acts like a magnet for a banking colossus unlike any other. When will the shares really fly? When NPL growth decelerates and the correlation between house prices and mortgage loans falls. An imminent scenario? Pas de tout. So what does Matti’s crystal ball whisper on BAC? I’ll say it again, I’ve said it before, BAC will trade at twenty four (dollars, not cents. After the horrors of 2008, you never know). But BAC will probably not hit 24 before we retest 10. A bear market, Dr. Pangloss, is not the best of all possible worlds.