BAC, the behemoth, reports tomorrow before the open. Both the report and the stock’s reaction should attract plenty of eyeballs, especially since BAC is up 60% (yeah!) to start the year after a dismal 2011 where it was down 60% (ugh.) The implied move for earnings is almost 5%, which is basically inline with the 8 qtr avg move of about 4.7%.
We are going to quickly lay out some of what we feel are the most important points of the Bull/Bear debate, especially given the stock’s relative out-performance to its peers this year.
-BAC has made significant headway in raising its capital ratios in the last 9 months. Last year it sold part of its credit-card operations, part of its China Construction bank stake, and preferred shares to Warrant Buffet. So far this year, it has already sold a few large office buildings (that it leased back) and announced plans this week to sell its non-U.S. wealth business for potentially up to $3 billion.
-Any indication that its cost cutting plan to shave $5 billion from annual expenses through 2013 is progressing smoothly should be met with enthusiasm. If that plan is offset by mortgage repurchase and litigation costs, then this positive could be negated (more on that shortly).
-The reaction to C earnings and the strong year to date performance for both BAC and C are signs that investors are looking for value (evidenced by cheap price/book ratios) in the financial sector. Also, expectations have come down since last year, even though stock price is lower – 21 out of 31 analysts have a hold rating BAC (1 sell, 9 buys, Thomson/First call).
-The size of the mortgage rep and warranty issue is massive for BAC, and the main reason for the underperformance of BAC in the last 2 years. From the most recent 10-K:
In connection with residential mortgage loans sold to GSEs and first-lien residential mortgage and home equity loans sold to investors other than GSEs, we or our subsidiaries or legacy companies make or have made various representations and warranties. Breaches of these representations and warranties may result in a requirement that we repurchase mortgage loans, or indemnify or provide other remedies to counterparties (collectively, repurchases). The Corporation and legacy Countrywide sold approximately $1.1 trillion of loans originated from 2004 through 2008 to the GSEs. In addition, legacy companies and certain subsidiaries sold loans originated from 2004 through 2008 with an original principal balance of $963 billion to investors other than GSEs.
That is the company telling you there are $2 trillion of loans at risk! However, they do have more visibility on the size of this problem relative to the past 2 years, and they have also already taken significant losses with regards to these loans. They also state that they have $15.9 billion in liabilities recorded against unresolved claims. Hard to say how close to the finish line they are on rep and warranty.
-BAC earnings have generally been a weak event over the past 3 years. BAC is down 9 out of the last 12 reports, much weaker than the market at large, and a reflection of consistently poor operating results at the bank. Weaker expectations this quarter (0.12/share on earnings is 29% less than last year, and revenue expectation of 22.5 billion is 16% less than last year) might help them get over the bar.
Looking at the chart, big resistance around the big figure at $10, where the stock stalled after the positive stress test news, and support at $8. Given that the stock is smack dab in the middle of those 2 important levels, it’s hard to pick a direction with good risk/reward. A range trade play might make more sense, but the Apr straddle is 0.46, only a 5% move for BAC, which doesn’t seem enough. But it’s a tough one to play. We’re going to stay away from this one this time around unless something becomes obvious. We may also revisit it following earnings to play the move or lake thereof.