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Trade of the Day: Bank of America (BAC)

BAC has been trading in a channel, but a post-earnings spike in April is likely


Recommendation: Buy BAC below $13 a share before April when it reports earnings, targeting $14 to $15.

Options Alternative: Buy to open BAC May $12 calls for $.60 per share or less.

Bank of America (NYSE:BAC) has emerged as a strong investment choice following the devastating 2008 financial crisis. Most recently, it reported that it is positioned well enough to sustain any similar financial crisis by passing the Federal Reserve’s stress test.

Regarding the importance of the tests, the Federal Reserve noted that they are a tool to gauge the resiliency of the financial sector. Also, significant increases in both the quality and quantity of bank capital during the past four years help ensure that banks can continue to lend to consumers and businesses, even in times of economic difficulty.

Because it passed the stress test, Bank of America will be able to increase its dividend, which has been less than a penny per share since the financial crisis. This is a coup for the bank because when it tried to increase its dividend in 2011, the Feds rejected the request.

New and Old Challenges for BAC

Bank of America took quite a hit after 2008, which was largely due to its acquisition of the now-defunct Countrywide. It was a provider of subprime mortgage loans, which as we know were a major contributor to the demise of the housing industry. At the beginning of this year, Bank of America announced it had reached an $11.6 billion settlement with Fannie Mae over loans that Countrywide sold to the housing finance agency between 2000 and 2009.

As it continues to try to right the problems from Countrywide, Bank of America does face new challenges. Bloomberg reports today that “concerns over how banks calculate reserves has led U.K. bank regulator Adair Turner and U.S. Federal Deposit Insurance Corp. board member Jeremiah Norton to call for tougher leverage ratios. Global supervisors in 2010 included a draft leverage ratio in an overhaul of rules, known as Basel III, drawn up in response to the financial crisis that followed the collapse of Lehman Brothers Holdings Inc.”

The news agency also reported that this stems from “a planned international limit on bank indebtedness that will be on the agenda of every meeting of the Basel Committee on Banking Supervision this year as regulators seek to wean lenders off their addiction to debt.”

Regulation Requirements Benefit Investors

Bank of America and other big banks like Citigroup (NYSE:C), PNC Financial Services (NYSE:PNC) and U.S. Bancorp (NYSE:USB), will also have to contend with the Consumer Financial Protection Bureau. It most recently began reviewing the effectiveness of the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act). As a credit card issuer, Bank of America has had to deal with losses in fees from the lucrative business.

The bureau will be gauging if new regulations have caused financial institutions to curtail deceptive and other bad practices. While the new rules may also be curtailing their earnings, I think financial institutions will continue to thrive, which will help them continue to contribute to the sector being the best performing segment of the S&P 500.

Bank of America, like other financial institutions, started hoarding cash after the financial crisis of 2008. It is holding more capital and liquid assets, which is attractive for investors.

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: From a technical perspective BAC is still channel-bound but likely to be attractive to buyers on any dips. A break above the current channel creates an upside target near $14 per share in the near term based on the prior extension. We are recommending an entry on the current pullback as recent declines have been abbreviated. More conservative investors may be more interested in waiting for a possible decline to $11 per share at the bottom of the channel. At this point we expect a decline that large to be a relatively low probability before earnings when the stock is expected to rally again.

We recommend a long position on this week’s pullback before BAC reports earnings on April 17. Based on the prior extension, BAC is expected to rise $2 above the current channel in the near term. If we get another consolidation near the $14 per share mark, we would recommend taking profits and closing the trade in the short term.

Options Alternative: Buy to open the May 12 calls. We recommend them at 60 cents per share or less.

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