Bank Of America's Huge Near-Term Catalyst

| About: Bank of (BAC)

Bank of America (NYSE:BAC) shares have more than doubled off of their 2012 lows on the back of improving company-specific fundamentals and subsiding macroeconomic headwinds. After their huge run, shares need a new catalyst to move higher. With BAC's famous one cent per quarter dividend, instituted during the financial crisis, investors have been starved of yield in the too-big-to-fail bank's shares. However, with improving return on asset numbers, smaller write-offs and with the shares still trading at only 87% of their December 31st, 2012 tangible book value of $13.36, I believe there is a catalyst on the near horizon that will send BAC shares higher still.

As a result of the financial crisis, the nation's largest banks became subject to the Federal Reserve's Comprehensive Capital Analysis and Review, or "stress test" to the rest of us. These yearly exams require our nation's biggest bank holding companies to prove their capitalization levels under various, adverse economic scenarios. While the days of TBTF banks worrying about failing these tests are largely a thing of the past, another, more relevant piece of the stress test is the Federal Reserve's determination of how ready the banks are to return capital to shareholders. This piece, I believe, will send BAC shares higher when the most recent CCAR results are released on March 7th.

BAC has been deleveraging under Brian Moynihan's leadership and as a result, equity levels are rising at Bank of America as the bank becomes more and more profitable with each passing year. While there is still plenty of work to do, I believe, when the results of the CCAR are released in March, BAC will be given permission by the Federal Reserve to resume dividend payments and/or share repurchases. As such, since investors have received close to nothing in the way of capital returns since the financial crisis from the Charlotte, NC bank, this announcement will send shares higher in anticipation of greater capital returns. In addition, the CCAR results should show that, based on BAC's latest earnings releases, the bank is in fact ready to return capital to shareholders in a big way over the coming years. This will be welcome news to shareholders as BAC will eventually return to a stock that income investors will buy instead of just those enterprising investors that are betting on BAC's share appreciation only. An "all clear" from the bank's regulator would also signal that the turnaround is in full effect and the company's worst days are certainly behind it.

So how much will shares appreciate if BAC is allowed to return capital to shareholders? The answer is, it depends. It depends on the timeline that is provided for returning capital via dividends and buybacks and also how much capital will be cleared for returning to shareholders. It seems logical that the regulators will let BAC off of restriction more gradually than is probably warranted in order to exercise caution. However, just the mere gesture of clearing BAC for returning capital to shareholders means the era of the financial crisis has passed and is ushering in a new area of some semblance of normalcy again. The Federal Reserve may decide that BAC can resume dividends and buybacks on a tiered schedule, which I think is most likely, or it may decide that BAC can resume dividends and buybacks at almost any rate the company wishes, which I think is probably remote. Assuming it is a tiered schedule, I think BAC will probably start off a little slower with its dividend increase, perhaps going to five cents per share per quarter, from the current penny per quarter. This would mean that BAC shares would yield just over 1.7% and BAC would only be paying out about $2.2 billion per year in dividends. In addition, this amount would easily be covered by BAC's operating cash flow.

With shares trading below tangible book value currently, BAC may decide to institute a share repurchase program, although I think this may be a little further out than the first half of this year. I think the dividend will be the priority of the board of BAC but buybacks will certainly be on the board's radar after the massive dilution that occurred during the financial crisis. The amount of buybacks that may be initiated, if any this year, would be dependent upon the dividend increase that was implemented. As the Federal Reserve is almost certain to put a cap on the amount of capital that can be returned to shareholders, I think buybacks will be more of a 2014 and beyond event, rather than a near-term occurrence.

The stress test results due out in a couple of weeks will provide investors with plenty of reading on the big banks, BAC included. I do think that this stress test result will prove overwhelmingly positive for BAC shareholders as its regulator is almost certain to okay the return of excess capital to shareholders, based on BAC's last few, very positive earnings reports. Unless the bank has some skeletons in the closet that the regulators find, which seems unlikely, I think we will see BAC shares move higher on the news that the financial crisis era is behind us and capital returns from a very strong, and improving bank have returned. In addition, with BAC becoming an income stock again in the medium term, a new class of shareholders that have sold BAC after the dividend was virtually eliminated will return and bid the stock up as the dividend is increased over the coming years and buybacks are reinitiated.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BAC over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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