[ by Howard Haykin ]

The headlines read:

"With Legal Reserves Low, Bank of America Faces a Big Lawsuit"  [dealbook]

"Analyst Dick Bove ... Sees Bank of America Stock Going to $30"  [247wallst]

"Is Bank of America a Buy at the Market's New High? (Yes)" [fool]

The Bulls.   Bank of America shares are going "gangbusters," regularly hitting new 52-week highs, and keeping pace as the Dow Jones reaches record highs - 3 in the past three days.  Influential Wall Street analyst Dick Bove has been a booster of BAC stock for quite some time and currently predicts shares will reach $30 - currently trades at $12.22.   [C-I Note:  When Bove speaks, people listen ... and invest.]   The Motley Fool's John Maxwell, while echoing Mr. Bove's recommendations, says: 

"Despite doubling last year, Bank of America , still appears to be relatively cheap by historical standards.  Among other things, shares of the bank are more than 40% below their pre-financial-crisis high (even taking dilution into account) and continue to trade far below book value." 

Yet, he attaches this qualification:  "With significant challenges still ahead, it's critical to have a solid understanding of this megabank before adding it to your portfolio."

The Bears.   Mr. Bove admittedly has expressed some bearish views about the bank, and is quoted as saying that Bank of America is operating at a disadvantage to rival Wells Fargo, seeing Wells Fargo "stealing market share from everyone" - and cites Bank of America in particular as a victim of Wells Fargo's growth.

Propublica's Jesse Eisinger, a frequent contributor to Dealbook, starts off his latest commentary, as follows: 

"Bank of America has been underestimating its legal risks for years, and brazenly so, according to its critics." 

Shortly thereafter, he adds:  "Yet the bank continues to face gargantuan payouts to clean up legal disputes from the bubble years. Now a lawsuit suggests that the bank’s mortgage portfolio could cost it tens of billions more than it had planned."

Part of Mr. Eisinger's comments pertain to Thursday's Federal Reserve announcement of how much capital the nation’s biggest banks must have to cover a “stress” situation.   Last year, the Fed permitted most of the big banks and let them pay out billions.  Bank of America, sensing a request would be unwelcome, didn’t even ask. This year, however, Wall Street expects that Bank of America will get the green light.

Fork in the Road.   The bank is very confident about the progress it's made and recently issued a financial reward to CEO Brian Moynihan.  Yet, how does one reconcile the legacy that Bank of America inherited from former CEO Kenneth Lewis - particularly his disastrous acquisition of Countrywide Financial and his over-priced acquisition of Merrill Lynch?

The bank has paid out billions for past mistakes and it continues to face gargantuan payouts needed to clean up legal disputes from the bubble years.  The latest development, Mr. Eisinger reports, is a lawsuit suggesting that the bank’s mortgage portfolio could cost it tens of billions more than it had planned.  In one big case, if things go wrong, Bank of America may be required to make good on many more billions worth of bad mortgages from Countrywide Financial.

This last comment pertains to an $8.5 billion settlement that insurer AIG, and others – including the New York (Eric Schneiderman) and Delaware attorneys general – are fighting.

Add to that Mr. Eisinger's opinion that Bank of America has kept its legal reserves low - perhaps dangerously so.  Bank of America rejects such criticisms, contending that its reserves are reasonable, based on its estimated probable payouts.  The bank wouldn’t raise them “based on speculation from 3rd-party observers who are not directly involved in any of these matters,” a spokesman said.

So is Bank of America vulnerable?  Compliance Insights has watched and reported on BofA's exploits with incredulous attention and, on a personal basis, we've never thought an investment in BAC shares was prudent.  [C-I:  Keep in mind that this investment view plus $2.25 will get you on the New York subways.']  Eisinger observes how Bank of America is contributing to the bottom lines of whole swaths of expensive Manhattan law firms who partners and associates are working all hours of the day to make the case that it isn’t.

Here's Mr. Eisinger's wrap up:

A look at Bank of America’s estimates for how much it will have to pay for its mortgage liability is telling. It has gone up steadily each year. In 2009, the bank had a reserve of $3.5 billion. By last year, it had jumped to $19 billion, with an estimate of additional loss of up to another $4 billion.

And so Bank of America seems to have been consistently underestimating its legal exposure. (And it has other, undisclosed legal reserves for different cases. The incentives to lowball those are much greater, because the public cannot scrutinize them.)

In keeping the reserves low, Bank of America has already won. If it turns out that the bank loses its cases and has to pay much more money, it nevertheless has managed to make its books look that much better for years. That surely helped as it has tried to dig itself out of its financial crisis hole.

“This is an accounting arbitrage,” says Manal Mehta, a hedge fund manager who has been on a lonely crusade for years to follow the complexities of these cases. “The accounting rules give you a lot of latitude in setting reserves,” he says. Bank of America is “hiding behind that.”

Fortune may favor the bold, but regulators just give them a pass.
 

And from our perspective, nothing we've just written provides any more sense for drawing a conclusion.  The pieces will fall where they may, and congratulations to those predictions that are on the money.   [Which is one reason we'd never make good analysts or, for that matter, good investors.]

For further details, go to:   [Dealbook, 3/6/13].