Name That Trade – Back to $BAC

by Enis June 11, 2014 10:38 am • Commentary

BAC has been on our radar ever since a lackluster Q1 earnings report.  We had a profitable bearish trade in the spring, which we closed for a triple.  In the rationale for that trade, we outlined the weak results and high expectations at BAC:

Of the large bank stocks, C and MS had the best all around reports, while JPM and BAC were on the weak end of the spectrum.  While the market punished JPM for its missteps (stock is trading near 5 month lows), BAC held up much better despite a weak overall report, particularly the slowing reserve release and the potential for further legal losses going forward.

Meanwhile, analyst expectations for BAC in 2015 and 2016 are much higher than for any of the other bank stocks.  Analysts have modeled in $1.59 in EPS in 2015 and $1.81 in EPS in 2016 for BAC, vs. only $1.04 in 2014.  Most of BAC’s peers only have earnings growth expectations of 5-10% over the next couple years.  A big reason for the jump is BAC’s continued restructuring program, but that’s an awfully large jump for a company that did not sound too optimistic on the earnings call last week.

This morning, the Department of Justice has indicated that it will not accept BAC’s $12 billion settlement offer, and insists on its initial fine of $17 billion.  For context, $17 billion is close to the stock’s total earnings from 2012 and 2013 combined.  Obviously, the market has discounted this settlement over the past 6 months, but I point it out because the government’s newfound aggressiveness in fining the banks (see its fine of BNP last week) is an ongoing regulatory risk for the too-big-to-fail financial stocks.

Despite a slew of negative headlines over the past couple months (including a suspension of the company’s buyback and dividend increase after the Fed found discrepancies in the company’s capital calculations), BAC stock has rallied back to the crucial $16 pivot level:

[caption id="attachment_41557" align="alignnone" width="600"]BAC daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg BAC daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]

The $16 level acted as support for much of the January – April period, before the stock gapped lower in late April.  The retracement looks like a good technical opportunity to play for a move back to the $14-$15 area, especially if BAC breaks the moving average confluence around $15.50, which is also the unchanged mark for the year.

The stock was down more than 1% this morning after the negative settlement news, though it has rallied back this morning to -0.75%.  We don’t want to enter a new position on such a down day.  Rather, we’re on the lookout for a move back to near $16, where we’re likely to enter a simple long Jul19th or Aug 16 put position, which would capture earnings in mid-July.

What’s our view on second quarter earnings for BAC?  First of all, JPM already guided the second quarter lower back in early May, with negative comments about the trends in most of the businesses.  GS research summarized the negative backdrop in May with this summary:

We point to (1) weaker equity (follow on) and debt capital markets issuance, which is likely weighing on secondary trading activity, (2) extremely low levels of rate volatility, (3) depressed mortgage trading activity, and (4) a return to more normal activity and volatility in commodities markets.

Analysts have modeled in a 4% earnings contraction year-over-year in BAC.  That is actually better than JPM, C, and GS, for which analysts have modeled in a 8-13% yoy contraction.  MS is the one standout after a weak second quarter number last year and strength in wealth management.

With that in mind, both the fundamental and technical backdrop look favorable to us.  For now, we’ll wait for the right entry for a new trade.