Bank of America racks up regulatory risk

Investors who made a killing on Bank of America should consider selling the stock before financial reform takes the spotlight.

By TheStreet Staff Mar 23, 2010 10:41AM

TheStreetBy David MacDougall, TheStreet


Bank of America (BAC) shares have outperformed those of rivals JPMorgan Chase (JPM) and Wells Fargo (WFC) during the past year. But the source of Bank of America's strength could also be its biggest risk.


As the largest US bank by assets with a market cap that's only slightly smaller than that of JPMorgan, Bank of America will likely be targeted by new regulations designed to clamp down on "too big to fail" institutions. While proposed regulations haven't been finalized, it's near certain that something will be signed into law that will restrict its banking operations, and the uncertainty of this process will weigh on Bank of America shareholders.


Bank of America stock has almost tripled during the past year as the company cut its leverage level and paid a dividend of about 2%. Bank of America's beta value is very high at 2.6, indicating the stock is extremely sensitive to market risk. With about 50% of the company's revenue coming from home loans, card services and deposits last year, Bank of America is more tied to personal finance than most of its competitors.


With the acquisition of Countrywide Financial, Bank of America came to control 20% to 25% of the home loan market. The company also holds 12% of US deposits.


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Bank of America's massive size has made it one of the most important institutions in the country. When financial markets began to shake, the government raced to stabilize Bank of America, JPMorgan, Wells Fargo and Citigroup (C) with cash infusions and guarantees, and shareholders started to view these measures as safety nets. Buying the bank's shares became less risky because it was being supported by the government, so the stock rose as the risks it faced decreased.


These guarantees will likely be removed and the industry will be changed so that if these companies fail, they won't hobble the economy. Because of this, the risk premium for financial stocks will need to go up, meaning the the share price would have to come down.


The Senate Banking Committee, led by Democrat Christopher Dodd of Connecticut, yesterday approved a plan to regulate risky securities and hedge funds, and impose new rules on banks. The final bill will likely change as it's prepped for a Senate vote, much like the health care bill. Regardless of its final form, new regulations will add costs to the banks and possibly strip away much of the safety net that investors have enjoyed during the past year and a half.


Most analysts are bullish on Bank of America and it is easy to see why. It has a gigantic customer base and a powerful name brand. It's difficult for individuals to avoid its services, especially with the acquisition of Countrywide. But it's stock could become more volatile during the coming months as talk of regulation picks up.


TheStreet rates Bank of America "hold." Now that Congress has passed its landmark health care bill, investors who have made a killing on Bank of America during the past year should consider selling the stock before financial reform takes the spotlight.


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