B of A stock isn't a bargain -- it's a gamble

The long-term outlook is unclear, and the short-term outlook is volatile.

By InvestorPlace Nov 1, 2011 9:00AM
By Jeff Reeves, InvestorPlace.com

Bank of America
(BAC) gave back about 7% Monday and was poised to crash and burn yet again Tuesday. However, the stock remains up over 30% from its 52-week low of around $5 a share. More impressively, that 52-week low was set intraday a mere four weeks ago.

A rollback after a red-hot run like that is to be expected -- so some traders may be wondering if now is the time to jump in.

After a rip-roaring run in October, it may seem like a good idea. But for most investors it is a very, very bad one.


If you're OK with high-risk, high-reward gambles, then by all means buy BAC. But don't fool yourself into thinking this is a long-term investment with so much uncertainty surrounding the stock, the financial sector and the broader economy.


I exchanged emails with a reader last week who told me Bank of America embodies Warren Buffet's axiom "I buy when others are panicking, and I sell when others are greedy." It is true that many folks remain down on the stock, but many folks also are down on the Miami Dolphins this year. Sometimes the negativity is justified.

 

Post continues below:

Here's the reality of Bank of America stock:


Customer backlash. If you think the only grassroots movement against financial firms is Occupy Wall Street, think again. There is a growing trend of Americans moving their money out of Bank of America and other major financials, either in outrage over the bailouts or outrage over hostile moves such as a proposed $5 Bank of America debit-card fee (though admittedly, Bank of America is reportedly now reconsidering the move). Just do a web search for "Most Hated Companies in America" and you’ll see Bank of America pretty high on just about any list.

 

A race to recapitalize. The loss ofcustomers is a double whammy for BofA. The financial stock faces higher capital requirements in the years ahead due to a global banking accord known as Basel III, a framework intended to reduce risk by preventing overlending and demanding a bigger cushion of cash be kept at financial firms at all times. This comes precisely at the time that savers and small businesses may be defecting. Bank of America needs plenty of cash on its balance sheet to carry on a robust banking business in a good market or to offset the risk of another shock if things go south. And despite$5 billion from Warren Buffett, a $8.3 billion sale of China banking assets and the $8.5 billion sale of its Canada credit card unit to TD Bank (TD), there is little evidence that the bank’s capital situation is rosy. Tier 1 Common Equity Ratio for BAC in its quarterly report just a few weeks ago was 8.65%, even as the European Union is insisting Tier 1 capital ratios of 9% in euro zone banks by 2013. Think about that. Even after these billion-dollar paydays, BofA would have to spend another year scrambling to raise cash if America was subject to these capital requirements as proposed across the Atlantic.


Measly dividend. Related to the capital issue is the lack of a Bank of America dividend, currently a measly penny per quarter for a 0.6% yield. The Federal Reserve squashed a proposed dividend increase at Bank of America this spring on fears that it wasn’t healthy enough to start throwing more money around. And Bank of America has yet to even ask for another dividend boost as it scrambles to pay off mounting legal obligations (more on this in a bit) and prop up its capital base. Considering the Fed just blocked a proposal for a MetLife (MET) dividend increase, it doesn’t appear that regulators are feeling generous, so don’t expect that penny per quarter to budge. Considering other banks like JPMorgan Chase (JPM) are pushing a dividend yield of 3%, this nominal payout provides no incentive to buy and hold BAC stock.

Subprime mortgage woes. This summer, Bank of America paid $14 billion to settle claims on mortgage-backed securities related to Countrywide. That came after BofA settled claims with government-run Fannie Mae and Freddie Mac in January. More mortgage fraud lawsuits are pending, including insurer American International Group (AIG) gunning for a piece of the pie. If bad debts related to risky mortgages weren’t bad enough, the prospect of prolonged litigation over lending practices makes the housing crisis weigh even heavier on the BofA balance sheet.


The economy, stupid. Perhaps the biggest risk to Bank of America is the fact the company is so intrinsically tied to the economy. Some bozo editor of a financial site threw his weight behind Bank of America year ago on the prospect that the company was going to lead the recovery this year, and in fact it has been quite the opposite. As consumers continue to suffer under a brutal job market and stagnant wages, the core business of lending and credit cards is going to suffer for U.S. banks. And even presuming the euro zone did figure out its debt crisis (something I vehemently disagree with) and the Congressional supercommittee fixes America’s own ugly budget without a hitch (don’t hold your breath), there are systemic problems of rising inflation and the very real fear of a China slowdown.

 

If you want to gamble on a short-term sentiment play, then Bank of America could gap up and be kind to you. That’s what it did just this October, to the tune of 15% in a few weeks. Of course, in August when sentiment swung the other way, it lost 30% in just a few days, but feel free to roll the dice.


But don’t fool yourself into thinking this is a bargain long-term play. Rebuilding Bank of America’s balance sheet and capital reserves will take a lot of time, and in the interim there are too many big uncertainties about litigation and broader economic woes. There’s a possibility the shares could go nowhere for a year or two or even more.


And with a measly one-cent dividend, what incentive do you have to stick around and wait? A better plan is to sit this trade out for a few months and buy in if the dust has settled. I have a strong feeling you won’t be paying much more than current valuations of $7 per share for quite some time.


For my bearish take on the entire financial sector, read a complete take on InvestorPlace.com.




Jeff Reeves is the editor of InvestorPlace.com. Write him at editor@investorplace.com, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.



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4Comments
Nov 1, 2011 11:30AM
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Sadly, Bank of America was omce THE best place to bank and to be employed. After Hugh McColl retired, it went downhill fast. No one wants to work there anymore, which means BoA has to pay higher than market wages and that puts an additional strain on the margins which means they have to add all kinds of fees to their products and services which infuriates customers. Add to that little ot no dividends and the worst customer service in the industry(and yes, I have the email exchange  with their online banking personnel to prove it) and you have the perfect storm.

 

Nov 1, 2011 4:36PM
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B of A needs to check out what happened to Netflix when they got GREEDY!
Nov 1, 2011 5:32PM
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Notice the timing of rescinding the debit card fees?  It came the same day the 50% haircut on Greek debt was announced.  Coincidence?  I think not.  They were probably thinking that they were off the hook for that $734b in unhedged PIIGS CDS they underwrote and are on the hook for should any of the PIIGS default.  It only took 48 hours for those expectations to blow up in B of A 's face.  PIIGS defaults are back on the table and anyone who underwrote CDS on this debt is has to be looking at tons of claims they won't be able to cover.  Greece will almost certainly default and will most likely be followed by Italy within 180 days.  Once the defaults begin, B of A will get hit hardest, followed by Citibank and Morgan Stanley ($690b and $440b respectively in unhedged PIIGS swaps underwritten; Citi does not disclose an unhedged figure, but it would not be much of a stretch to conclude that most of their $690b PIIGS position remains unhedged).
Nov 1, 2011 5:45PM
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BofA is in such risk now, and largely due to bone headed moves such as buying up Countrywide Financial and getting themselves embroiled in the subprime lending mess, and then trying to sell those toxic debts to other companies and even the US Tresury who has since sued them for "liar sales" if you will; they're IMO, a bit risky not only in terms of stock questions, but in terms of just having them hold one's savings.  Even 1 day before the $5 debit card announcement I had opened an account at a community bank, with plans of moving my money.

 

And part of it, is I smelled something nasty comming.  With the bank getting itself in constant trouble (of which though the Durbin amendment is the thing many banks whine about, it is not the route of all of BofA's troubles, and either way would have no effect on all their bad investments, lawsuites, and everything else); you just know they would likely try to push it off onto the customer somehow.  Well I'm sorry, but the tax payer had to bail them out due to governmental decision with this whole "too big to fail" argument of theirs.  I don't want them to help bail themselves out with my money, yet again, simply because it's in their depository...

 

It goes back to a very simple queston.  If one is looking for an investment broaker, to handle one's retirement funds, life savings, etc; would one want to entrust their money to a person in deep financial trouble, who's getting sued left and right, and bleeding out money, largely due to their own bad business decisions, and mismaneagement of their own funds.  Someone, who because of their own bone headed moves, if they are without conscience would have the motive, and if given the funds, the opportunity to steal?  Or would one chose someone who is on sound financial footing, having made good decisions when it came to their own business decisions, and their own fiscal handling?  Now some people have enough moral fiber, that even with both motive and opportunity, they wouldn't take the funds; but others don't.  And there's a reason in this (in terms of the risk involved) on why lenders do a credit check before lending funds.

 

IMO, a bank that's in serious trouble, due to bad business decisions, who is looking for ways to build up revenue to set them to rights, isn't necessarily a good, non-risky choice in terms of institutions to trust one's own savings to.  And so I planned to move my money even before the debit fee announcement.  When that announcement came out, it only confirmed what my gut was telling me; though and truth be told that fee announcement was neiter the first, nor will it be the last fee BofA tries to create, and stick onto it's customers.  They have their own history wrt fees and customer service in this regard, which multiple customer service survey's have pointed out time and again.  The risk isn't just a question of whether they'll survive or not, and whether the FDIC would be asked to cover accounts in a bank with over $1 trillion in deposits; it's given all te trouble they're in, exactly what will they try to stick to their customers, in order to try to use their customers as a revenue source to make up for all the losses their own business decisions (along with the law suites that have been filed as a response to many) have brougt upon themselves.

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