BofA Headed Back Below $10?

Includes: BAC, C, GS, JPM, WFC
by: Rakesh Saxena

Goldman Sachs (NYSE:GS) analyst Richard Ramsden says that the bigger banks have increased their earnings potential “mostly via long term accretive deals.” But Mr. Ramsden fails to recognize that the real driving force behind the recent process of accretion in the financial services industry thus far has been government aid and intervention, in one form or another.

On Monday, citing an improved earnings outlook, Goldman raised its call on Bank of America (NYSE:BAC), and other Wall Street majors, to “attractive” from “neutral”. But that outlook is premised in the hope that even a weak recovery will result in a decisively positive credit and investment environment.

In this writer’s opinion, BofA is headed straight back into single digits; build short positions in the $17.50-$20 range, targeting a highly profitable exit by mid-2010.

BofA’s financial statements (six months ended June 30, 2009) certainly show that the bare foundations (namely capitalization and asset reclassifications) for a substantive enhancement in future earnings are in place. The real question, however, is this: has a qualitative turnaround been achieved in the bank’s interest and non-interest income, and will the debt servicing capabilities, today and in the foreseeable future, of BofA’s customer base keep loan-delinquency requirements in check over the next 2-3 quarters?

The US$36 billion provision (as of June 30, 2009) for credit losses may well support the integrity of capital adequacy ratios today. The income from investments and trading (roughly US$17 billion) reflects the pricing environment in the first half of 2009. But how will the V-shaped (or U-shaped) recovery impact BofA’s balance sheet during the course of next year? Already, hard data from the economy (including the jobless rate) is offering mixed signals, at best.

Goldman claims that BofA’s share price (US$16.75) “does not reflect the prospects for earnings growth.” Is the Goldman update simply a bet on an economic growth in the midst of an unwinding of record levels of actual and contingent intervention? Or, should we all be expecting to reap the rewards (yet again) of a second stimulus package?

This writer is not suggesting that BofA shares are due for any imminent collapse; too many institutional and retail investors are in wait-and-see mode. On the contrary, the slide into single digits will begin once analysts realize that, even if the IMF’s latest growth forecast (1.5% in 2010) comes to fruition, the economy will be unable to generate any compelling BofA-specific value drivers demanding upward revisions in the diluted EPS (0.75, as of June 30) or, for that matter, in any other measurement of value.

With $2,254 billion in assets, BofA is, in many respects, best-poised to gain from in sustained economic growth. But will there be any verifiable advances in home prices and family balance sheets in forthcoming months? If not, the accretion process Mr. Ramsden referred to could well be witnessed in reverse, exposing the weaknesses in Goldman’s “conviction buy list” of Wall Street banks.

In fact, the first shock waves for America’s big banks could possibly from a non-U.S. source early next year, when the pressure to service (i.e. refinance) $400 billion of corporate and bank debt (denominated in foreign currencies) in the emerging market wrecks havoc with lending spreads and credit quality.

Disclosure: Modestly short BAC; seeking to add above $18