Bank of America Downgraded Following Stress Tests

NEW YORK (TheStreet) -- Bank of America (BAC) has been one of the hottest big-bank stocks for a while, but Atlantic Equities analyst Richard Staite on Monday cut his rating on the bank's shares to "neutral" from "overweight."

Bank of America has been quite a strong play on the industry's recovery over the past two years. The company's shares closed at $17.56 Friday, up 13% this year, following returns of 34.5% in 2013 and 110% in 2012. The shares trade for 10.8 times the consensus 2015 Earnings estimate of $1.62 a share, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is $1.31.

Staite cited several reasons for the downgrade, including the expected large year-over-year decline in first-quarter trading revenue expected for the largest industry players, the strong price performance this year, and the results of last week's first round of Federal Reserve stress tests.

The analyst lowered his first-quarter EPS estimate for Bank of America to 26 cents from 32 cents, while lowering significantly his 2014 EPS estimate to $1.33 from $1.48 and cutting his 2015 EPS estimate to $1.68 from $1.80. Staite also cut his price target for Bank of America to $18.50 from $20.00.

In its Dodd-Frank Act Stress Tests (DFAST) last week, the Federal Reserve tested 30 large banks' ability to remain well capitalized, with minimum Tier 1 common equity ratios of at least 5.0%, through a nine-quarter "severely adverse" economic scenario. All the banks passed, except for Zions Bancorporation of Salt Lake City.

But Bank of America's stress-test showing wasn't particularly strong, as its minimum Tier 1 common equity ratio under the severely adverse scenario was 6.0%, which was second lowest among the 29 banks passing the test.

That result doesn't necessarily bode well for the second round of the stress tests, which is the Comprehensive Capital Analysis and Review (CCAR), which applies banks' plans to deploy excess capitals to the same severely adverse scenario. This means Bank of America's shareholders may be disappointed with its plans for dividend increase and/or stock buybacks. It could even mean the company's 2014 capital plan gets rejected by the Federal Reserve.

"The stress test showed that BAC has a $13bn buffer over the minimum requirement and thus should just about be able to carry out a $5bn buyback and pay a $2.5bn dividend although we are somewhat nervous that it or another bank could be failed on a qualitative basis," Staite wrote in a note to clients on Monday. The analyst estimates Bank of America will raise its quarterly dividend to six cents from a penny.

Two Upgrades

Also on Monday, Staite upgraded Wells Fargo (WFC) and U.S. Bancorp (USB) to "neutral" ratings from "underweight" ratings.

For Wells Fargo, Staite raised the price target to $53 from $48, while lowering his first-quarter EPS estimate by a penny to a dollar, lowering his 2014 EPS estimate to $4.06 from $4.10, and lowering his 2015 EPS estimate to $4.12 from $4.16.

For USB, Staite raised his price target to $44 from $39, while leaving his first-quarter EPS estimate unchanged at 75 cents, lowering his 2014 EPS estimate slightly to $3.10 from $3.12, and lowering his 2015 EPS estimate by a penny to $3.35.

"We see these banks as a simple and safe way to play rising US interest rates. They both performed well in the stress test and we believe the revenue headwind from declining mortgage refinancing is now mostly over," Staite wrote when discussing the upgrades.

Wells Fargo and U.S. Bancorp have been the strongest performers among large-cap banks for several years. Wells Fargo's 2013 return on average tangible common equity was 17.74%, while U.S. Bancorp's ROTCE was 24.00%, according to Thomson Reuters Bank Insight.

Top Picks

Staite wrote that his "top picks" in the banking sector remain PNC Financial Services Group (PNC) of Pittsburgh and JPMorgan Chase (JPM). He considers PNC another low-risk interest-rate play, and also cited the company's strong performance in the stress tests.

For JPMorgan Chase, Staite cited a low valuation, the company's strong franchise and the possibility of a turnaround in trading revenue.

PNC's shares closed at $86.87 Friday and traded for 11.6 times the consensus 2015 EPS estimate of $7.52. The consensus 2014 EPS estimate is $7.00. Staite on Monday raised his price target for the shares to $100 from $92.00.

JPM closed at $60.17 Friday and traded for 9.5 times the consensus 2015 EPS estimate of $6.35. The consensus 2014 EPS estimate is $4.90. Staite's price target for the shares was raised on Monday to $68 from $66.00.

Shares of Bank of America were down 1.3% in midday trading to $17.32, while U.S. Bancorp was up 0.6% to $43.27 and Wells Fargo was down 0.4% to $48.95.

PNC's shares were down 0.3% to $86.65 and JPMorgan was up 0.8% to $60.63.

Some Banks Dilute Shareholders, Despite Buybacks

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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