Why Citigroup and Bank of America Are Still Buys

Bank of America (NYSE: BAC): Originally recommended on Sept. 20/10 at $13.40. Closed Friday at $11.44.

Citigroup (NYSE: C): Originally recommended on Sept. 20/10 at $3.95. Closed Friday at $4.11. (All figures in U.S. dollars.)

On Tuesday, stock markets suffered their worst day in two months, with the NYSE led down largely by one of my favorite stocks, Bank of America. I recommended BAC late last month as a speculative buy with a 12-month horizon. Unfortunately, that was just before the news broke of the nationwide foreclosures scandal in the U.S. which has put what amounts to a freeze on bank sales of repossessed properties and threatens to further complicate the housing mess. BAC stock responded negatively to the news.

But that wasn't the only problem. Last week the bank announced its third-quarter results and they were a complicated mixed bag. The company announced it is taking a $10.4 billion goodwill impairment charge which resulted in a $7.3 billion loss for the quarter. Without that impairment charge the company would have actually earned $3.1 billion.

Credit improved so the bank was able to scale back almost $2 billion of its loan-loss reserves. But the costs of financial regulation have begun to bite as BAC was unable to pass through some fees to its bank depositors and credit card borrowers.

While all this was going on, some bondholders including the New York Fed, PIMCO, BlackRock, and others threatened to bring suit against the bank demanding that they buy back as much as $47 billion in mortgages. These were bundled and sold by Countrywide Financial Corp. which Bank of America bought at the height of the financial meltdown, supposedly at a great price. All this drove down the stock by over 4%.

Personally, I saw this as a buying opportunity and added to my already large position. But the reason I gave such a long time horizon in my recommendation is that there will be tough times like this with the banks until the economy settles down and all the fallout from the real estate meltdown has been cleansed through the system.

Citigroup also announced earnings last week, which were better received than those of Bank of America for a couple of reasons. First, the company reported that third-quarter net income came in at $2.17 billion or 7 cents a share, including preferred dividends. That compares with a loss $3.2 billion (27 cents a share) during the same period a year earlier. Second, analysts and investors liked what the company had to say about its global prospects and the continued wind-down of U.S. government ownership. The stock rose, then sold off again after the Bank of America news. But all in all, Citigroup continues to gradually work through its problems and I'm sticking with my recommendation to buy the stock.

Action now: Both Citigroup and Bank of America remain as Buys.

Disclosure: Long C and BAC