2013 will be another year of recovery for the global economy in my opinion. That being said, Bank of America (NYSE:BAC) has risen about 100% since I first suggested owning shares (check this out). The first smallish purchase was at the $5.70 level. I added significantly to that position at about $5.15/share after writing this article. I even put my projection of a double from that point, in 12-18 months, and was scoffed at.
Everyone hated BAC, and the fact that they had toxic mortgages, foreclosure issues, a weak balance sheet, and an awful reputation from having to take bail-out money, gave me the perfect contrarian stock to own in my risk basket.
In February, I added it to our "Team Alpha" core holdings, from the risk basket we held (as explained here). It was, and still is, my belief that as BAC cleans up its balance sheet and continues to profit without taking on those risky mortgages any longer, that they will have achieved Brian Moynihan's goal of having the largest "small bank" in the world.
Now that the Fed has ramped up their latest QE4 program, I believe this will finally catch up to some of these banks. I believe that taking some chips off of the table in BAC is a prudent move until some of the dust settles.
The Share Price Has Performed Well
The share price has more than doubled since that first recommendation, and now stands at $10.61/share. Not to mention that the stock is still selling at a 48% discount to book value.
Debt to equity has dipped but not at the same rate as the share price increase, and that could be the first indication of the bank needing a new catalyst to grow from here. The chart looks really good for all intents and purposes, but the Fed has continued to take the policy of keeping interest rates at record lows.
With ZIRP in place until the unemployment rate drops below 6.5% and inflation goes no higher than 2.5%, the Fed stated that they will continue placing pressure on both the short and long end of the interest rate spectrum.
My thesis on this fact is that banking will need to find another way to grow revenues and earnings to continue growing at the pace that they have been. Specifically, Bank of America.
As BAC had the time to get rid of toxic assets, and reshape its business model, the room for recovery from the lows, to growth, was not as difficult as investors thought. When you're all the way down there is no way to go but up. That being said, there is just so much juice to be squeezed out of even the ripest of oranges. The time has come for BAC to begin lending again. The company needs to expand its mortgage loans and take on some additional risks in my opinion, in order to have some serious growth from here. That is the problem though.
The Risk/Reward Factor
The same issue that led me to my original buy suggestion, now leads me to my sell recommendation; risk/reward.
The Fed has driven mortgage rates down, as well as all other interest rates down, to the point that many of our lending institutions are not willing to take on risk with such low rewards.
The two most popular mortgage terms (30 year and 15 year fixed rates) are at all time lows. If I were a bank, and I was able to make money by NOT lending, why would I want the risk? In turn, the banks have tightened up their requirements to actually obtain a mortgage (or an loan for that matter) because they do not want to fall into the same trap as they did back in 2006-2008; lending with virtually reckless abandon.
Guess which bank has led the way DOWN in mortgage lending:
Ok, how about auto loans?
One last little tidbit; how about the banks who received taxpayer money (the big banks of course) and how that relates to putting that money back into the economy via small business loans?
Small and mid-sized banks have carried the load, while banks like BAC have cut their small business lending in half. (Yes, BAC is a giant bank)
This is not an indictment of BAC by any means. The company has made strong headway in its stated goals, but now it is time to take this deeper view.
Lending guidelines have changed as well. If the banks are going to lend, they also want pristine conditions. The problem is that this could hamper further expansion of revenues and profits. That in turn could hinder share price appreciation.
Lending standards have tightened and demand has increased, but the banks are not lending, no matter what the talking heads tell you. (See the previous chart)
I sold BAC when the share price was in the $9.75 range per share. I do not believe that the current share price of $10.61 is in trouble, I believe that it just might be dead money until the Fed lets up a bit.
I believe Bank of America has reached an inflection point. The company can continue doing what it's doing and making small bank profits, but the top line and the bottom line might not be able to grow until the company begins lending and taking on more risk. This chart shows what has been going on in various lending and loan balances:
All metrics are down, and while there has been some rebounding, I think the Fed has once again drawn a line in the sand.
Thusly, in less than 12 months the share price has doubled. Rather than sitting with dead money for 2013, (do not dismiss the selling pressure of the fiscal cliff and year end tax selling either, folks) why not put that money to work in other opportunities?
I think taking profits right now might be healthy for your portfolio.