Bank of America to Fall Off Cliff, Then Bounce: Analyst

NEW YORK ( TheStreet) -- Investors who are looking for a recovery play may have an excellent opportunity to scoop up shares of Bank of America ( BAC) on the cheap, as the " Fiscal Cliff" drama continues in Washington.

As nearly all of our readers know by now, the federal tax cuts extended by President Obama as part of a deal with Republicans in Congress in August 2011 will expire at the end of the year, without a new deal. Along with the tax increases, the Budget Control Act of 2011 requires a large cut in federal spending, in an effort to reduce the annual federal budget deficit by $1.2 trillion over 10 years. Many economists believe that "falling off the fiscal cliff" at this stage of a slow economic recovery would cause the U.S. economy to slip back into recession.

Guggenheim Securities analyst Marty Mosby on Monday said in a "Tactical Trading Sell" report that Bank of America "is one of the leading candidates for a significant correction if the pressure on the U.S. economy from the Fiscal Cliffs begins to build."

Mosby actually rates Bank of America a "Buy," with a $12 price target, which would represent 21% upside, however, the rating and the target have 12-month outlooks, while Mosby believes "BAC could trade below $8 over the next three months if it becomes apparent that the U.S. economy is about to be pushed over several of the upcoming Fiscal Cliffs."

The analyst's short-term trading range for the next three months for Bank of America is from $7 to $8 a share, "based on a 60% price to current tangible book value multiple. BAC currently trades at 73% of current tangible book value." Mosby said that "the risks to this tactical trading call are twofold: Washington politicians work together to craft the 'Grand Bargain,' avoiding the upcoming Fiscal Cliffs, or the economy builds up enough momentum to absorb the unfavorable impacts of higher taxes and spending cuts and still keep growing."

Mosby said that his firm's Washington Research Group "currently estimates a 65% probability that the U.S. economy is pushed over several of the initial Fiscal Cliffs."

According to the Washington Research Group's report from Nov. 21, despite the wave of optimistic media reports, that the Republican leadership in the House of Representatives and the Senate are ready to cave on their stance against any tax increases, even for higher-income taxpayers, several major sticking points need to be addressed before "there can be real optimism on a deal to prevent December ending like Thelma and Louise."

These issues include, but are certainly not limited to the following:
  • President Obama's insistence that marginal tax rates rise for individuals making over $200,000 a year, and for couples earning $250,000. Some conservative political pundits have cheerfully pointed out that the GOP may wish to give in on this point, since "protecting the rich" from tax increases doesn't seem to be helping the Republicans win elections.
  • Elimination of deductions and tax loopholes. Guggenheim's senior political analyst Chris Krueger said in the Nov. 21 report that a different way to soak higher-income tax payers could be possible, "if effective rates (capping and/or limiting deductions) will be enough for Democrats, or if statutory rates (reverting back to 39.6% for those households making over $250K) will be required."
  • Entitlement reform. Krueger said that "what is missed by several media organizations who run headlines similar to 'Republicans Willing to Deal on Revenue' is the IF in that pledge." Krueger, who said "there is bi-partisan support to cut the providers," including hospitals and drug companies, "but beneficiary reform produces a scorched-earth defense for penny one."
  • Spending Cuts. There have been no details yet on negotiations over spending cuts, although media reports on defense procurement activities show that the Pentagon is anticipating a major budget reduction.
  • Debt ceiling. Here we go again. There's no denying that $16 trillion is a very ugly figure.

Mosby singled out Bank of America for several reasons. "Since this correction started earlier this fall, the Large Cap Banks have experienced an average 5% decline in stock prices. During this same time, BAC's stock price has actually increased 3%, he said." Bank of America also has major legacy mortgage risk, mainly from its acquisition of Countrywide in 2008.

In its quarterly 10-Q filing with the Securities and Exchange Commission, Bank of America reported that the total unresolved mortgage repurchase claims against the company had risen to $25.5 billion as of Sept. 30, from $12.6 billion at the end of last year. Mosby said that "we have calculated a range for potential remaining after-tax losses of $15-50 billion. While our best-case scenario could be funded with about one year's earnings, the worst-case scenario could create a $2 haircut to BAC's year-end estimated tangible book value per share of $14."

Of course, Bank of America's mortgage putback risk could be greatly curtailed if the economic recovery strengthens, making the company's stock very sensitive to the continuing stream of economic reports, which have recently underscored a housing recovery.

Mosby said that "that until short-term rates begin to rise, BAC's earnings power is between $10 billion and $12.5 billion a year."

Bank of America could also be especially sensitive to a prolonged fiscal cliff drama because of the stock's valuation. The shares were up 79% year-to-date when they closed at $9.90 Friday, following a 58% decline last year. While the shares look cheap at 0.7 times their reported Sept. 30 tangible book value of $13.48, they trade for more than 10 times the consensus 2013 earnings estimate of 97 cents a share, among analysts polled by Thomson Reuters, which is relatively pricey, when compared to the rest of the "big four" U.S. banks:
  • Shares of Citigroup (C) closed at $36.03 Friday, returning 37% year-to-date, after dropping 44% in 2011. The shares trade for 0.7 times their reported Sept. 30 tangible book value of $52.70, which is a similar valuation to Bank of America. However, the shares have a much lower forward P/E ratio, trading for 7.8 times the consensus 2013 EPS estimate of $4.64.
  • Shares of JPMorgan Chase (JPM) closed at 41.09 Friday, returning 27% year-to-date, following a 20% decline last year. The shares trade for 1.1 times tangible book value, according to Thomson Reuters Bank Insight, and for 7.7 times the consensus 2013 EPS estimate of $5.32.
  • Wells Fargo (WFC) closed at $33.20 Friday, returning 24% year-to-date, following a decline of 10% during 2011. The shares trade for 1.6 times tangible book value, according to Thomson Reuters Bank Insight, and for 9.2 times times the consensus 2013 EPS estimate of $3.63

Interested in more on Bank of America? See TheStreet Ratings' report card for this stock.

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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