Financials' Santa Rally Turning Into Cliff Collapse (Update 2)

Updated with market close information and updated returns and ratios for Bank of America.

NEW YORK ( TheStreet) -- The Santa Clause rally for bank stocks fizzled last night with the failure of House Speaker John Boehner's "Plan B" to come to a vote.

With Boehner (R., Ohio) and President Obama both making concessions during their negotiations over the past week to avert the expiration of reduced federal income tax rates and concurrent spending cuts mandated for 2013 under the Budget Control Act of 2011, the KBW Bank Index ( I:BKX) was up 5% from a week earlier, through Thursday's close at 51.90. The index on Friday pulled back over 1% to close at 51.28, with all 24 index components seeing declines, except for US Bancorp ( USB), which was up four cents to close at $32.48..

Shares of Bank of America ( BAC) were down 2% to close at $11.29, and Citigroup was also down nearly 2% to close at $39.49. Shares of Wells Fargo ( WFC) were also down nearly 2%, closing at $34.48, while JPMorgan Chase ( JPM) saw its shares pull back 1% to close at$44.00.

GOP Not Budging on Tax Rates After All


When the Fiscal Cliff negotiations began, President Obama was insisting that federal income tax rates should rise for couples earning $250,000 per year or more, while agreeing that tax-rate cuts should be extended for everyone else. The Republicans initially insisted that federal revenues only be enhanced through caps on tax deductions and the elimination of loopholes.

President Obama last week said he would be willing to limit tax rate increases to taxpayers earning $400,000 per year or more. After criticizing the president for moving slowly during the negotiations, Boehner said that he would move ahead with a "Plan B" bill to raise the federal income tax rate for couples or businesses earning $1,000,000 or more per year to 39.6% from 35%, while protecting all other taxpayers.

In an humiliating defeat late on Thursday, Boehner said in a statement that the House of Representatives "did not take up the tax measure today because it did not have sufficient support from our members to pass. Now it is up to the president to work with Senator Reid on legislation to avert the fiscal cliff."

Boehner added that the House had "already passed legislation to stop all of the January 1 tax rate increases and replace the sequester mandated spending cuts with responsible spending cuts that will begin to address our nation's crippling debt. The Senate must now act."

Since the Republicans have made it clear that they won't even allow tax rate increases on the highest income earners, and the President is insisting on tax rate increases on incomes ov $400,000 or more, it would appear highly unlikely for Senate Majority Leader Harry Reid (D., Nev.) to push the Senate to pass anything palatable to the Republicans.

AMT Time Bomb


Many economists have predicted that "falling off the Fiscal Cliff" will push the U.S. economy back into recession. Another major problem over the short-term is the Alternative Minimum Tax. The AMT was enacted in the 60's, in order to make sure that taxpayers with a large amount of deductions to their taxable income would be forced to pay a minimum federal income tax.

The AMT law is not indexed for inflation. Each year, Congress passes a "patch" in order to address this problem. The patch hasn't yet been passed, and time is short, because the Internal Revenue System needs to know the AMT rules for 2012, in order to do correctly process tax returns and tax refunds, beginning in January.

Acting IRS Commissioner Steven Miller sent a letter to Congress in November and another letter on Wednesday, saying that "the most recent AMT Patch, and the exemption amounts of $74,450 for joint filers and $48,450 for single taxpayers, expired at the end of 2011," and that without a new patch for 2012, "the current-law AMT exemption amounts are much lower: $45,000 for joint filers and $33,750 for single taxpayers."

"This means that 30 million additional taxpayers will become subject to the AMT on their 2012 income tax returns."

Miracles do happen. Our friends in Washington may get their act together and pass the 2012 AMT patch, but if they do not, Miller said that "most taxpayers may not be able to file their 2012 tax returns until late March, or even later." When factoring in the software changes required with no AMT patch and the calculations taxpayers will need to make in order to find out whether or not the AMT will apply to them, Miller said "it is becoming apparent that an even larger number of taxpayers - 80 to 100 million of the 150 million total returns expected to be filed - may be unable to file."

So not only will $30 million taxpayers face higher taxes for 2012, up to 100 million taxpayers could see a significant delay to their tax refunds. That would be sure to have a dire effect on the economy during the first quarter.

Euphoria and Volatility


Bank of America's shares have now returned 104% year-to-date, following a 58% decline during 2011. Mounting evidence of a sustained recovery in U.S. housing prices, along with the overall economic recovery, have propelled the shares, although they were still down 15% from the end of 2010.

The shares have been quite volatile this year, quickly rising to a closing price of $9.81 on March 20, then sliding to a close at $6.83 on May 21, before continuing a rocky climb to Thursday's closing high of $11.52, so Bank of America could be especially susceptible to the Fiscal Cliff and the possible AMT-driven delays of tax refunds next year.

Bank of America's shares were till discounted at Friday's close, trading for 0.8 times their reported Sept. 30 tangible book value of $13.48, however, the shares appeared relatively expensive in the current environment for large-cap bank stocks, at 11.8 times the consensus 2013 EPS estimate of 96 cents, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is $1.25.

BAC Chart BAC data by YCharts

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

-- 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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