Why Bank of America Is Higher Amid Light Volume

Despite positive news on the job front this morning, there's palatable angst underlying shares of the banks today, as investors wait to learn which of the nation's 18 largest lenders will be allowed by the Federal Reserve to increase their quarterly dividend payouts and/or share buyback programs. With the announcement scheduled for 4:30 p.m. ET, shares of Bank of America (NYSE: BAC  ) are up by $0.09, or 0.75%, in afternoon trading.

Investors breathed a collective sigh of relief last week after the Fed announced that 17 of the 18 banks examined via the now-annual stress test, passed it -- click here to access our extensive coverage of the stress tests. The clear standouts were the regional lenders given their limited exposure to the risky world of investment banking. To name just one example, U.S. Bancorp (NYSE: USB  ) saw its tier 1 common capital ratio fall by only 70 basis points down to 8.3%, or well able the 5% minimum, after running the Fed's "severely adverse" economic scenario. By comparison, JPMorgan Chase's (NYSE: JPM  ) and Citigroup's (NYSE: C  ) fell by 410 bps and 440 bps, respectively. And for its part, B of A's ratio fell by 460 bps down to 6.8%.

The question now is whether or not the Fed will allow these lenders to increase the amount of capital they return to shareholders. As intimated above, the answer to this is a mere hours away, when the central bank releases the results of this year's comprehensive capital analysis and review, or CCAR. Just to be clear, the stress tests are used by the Fed to determine whether a bank has sufficient capital to survive an economic downturn akin to the financial crisis, if not worse. Assuming it does, in the CCAR process, the Fed examines whether the bank should be allowed to return some of any excess capital to shareholders by means of a dividend increase or share buyback.

While some banks have already announced what they've asked for from the Fed in this regard, B of A has stayed quiet. Citigroup, for example, asked regulators for permission to buyback only enough stock to counter dilution from routine share issuances stemming from its compensation scheme. Meanwhile, JPMorgan's buyback request was purportedly sliced in half compared to its $15 billion program last year, though analysts are expecting the bank to raise its quarterly dividend by $0.06 per share. And rounding out the top four banks, sans B of A, at the end of last year, the CEO of Wells Fargo's (NYSE: WFC  ) announced that he would move to increase the amount that it distributes to shareholders. Prior to the crisis, the nation's largest mortgage lender paid out anywhere between 35% and 50% of its earnings via dividends. Since then, that figure has only just reascended to the high-20% range.

Other than saying that a dividend increase is "on the table," B of A's CEO Brian Moynihan has otherwise stayed quiet. His reticence in this regard is largely attributable to the public and humiliating denial of the bank's request in 2011 -- something many people believe has been his biggest mistake since taking over at the beginning of 2010.

That being said, B of A stands a good chance of being able to increase its now-nominal quarterly payout of $0.01 per share. As I discussed here, for a bank to obtain approval, according to the Fed, it must demonstrate the "ability to maintain capital above each minimum regulatory capital ratio and above a tier 1 common ratio of 5 percent on a pro forma basis under expected and stressful conditions throughout the planning horizon."

So, how does B of A measure up? Pretty good I'd say. At the end of the third quarter, its tier 1 common capital ratio was an impressive 11.4%, or more than twice the requisite minimum. And even after the extreme scenarios envisioned by the stress test, it fell to only 6.8%, or 180 bps higher than 5% called for. With this in mind, while I've certainly been wrong before, it seems clear that B of A, at the very least, has a great shot of attaining approval this go-around. And it's this feeling, in turn, that's fueling the bank's share price today.

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  • Report this Comment On March 14, 2013, at 2:33 PM, TheDumbMoney wrote:

    This analysis is basically why I took an option position in BAC earlier this year when it was in the mid-to-high 11s, with a May 2013 expiration and a $10 strike. If my analysis fails, I'll be happy to convert at $10 and treat my option costs as a reasonable cost of my wager, which do not negate the value I see in BAC shares. And if my (and your) analysis is correct, I think there is a good probability or a bump in share price that I will benefit disproportionately from, due to my mildly-leveraged position. To me it is a decent risk-reward scenario, somewhat of a win-win, and a way to play an option while staying true to my credo of being a long-term investor and not a speculator. We shall see.

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