Buy Sell Short BAC is Bank of America a Good Profitable Trade After Stress Tests

Bank of America Bullish Case

The bull’s case for buying BAC hinges on the fact that unlike other bailout babies like AIG and Citigroup, the core value of the Bank of America franchise has not evaporated on Main Street to the same degree it has on Wall Street. Whether it is simply the beneficiary of being the “next” news on a crisis Americans have grown tired of hearing about and have started to believe affects all of “them,” or it is because people actually see a difference between what happened at BOA and the other big banking bailouts remains to be seen.

Furthermore, Bank of America was a healthy big bank until the Merrill Lynch deal soured beyond expectations. Before that, BAC snapped up Countrywide Mortgage in a sweetheart deal that leaves it with much upside and the government with are large portion of the downside. Countrywide comes with a nationwide mortgage origination infrastructure that can be used to supplement the Bank of America mortgage business.

Bank of America still has a healthy (for current economic conditions) deposit and lending business through its retail banking units, and also has a large brand name presence in credit cards.

Additionally, if the markets recover, Merrill Lynch might eventually generate the kind of profits that make people forget all about those rushed through, end-of-year bonuses that cost Ken Lewis his spot as Chairman of the Board of Directors.

Bearish Case for Bank of America

Of course, the same factors that weigh in Bank of America’s favor in a recovering economy are the anchors that will drag it down if the economy declines further. The stress test results released by the government require BAC to raise $34 billion by November 9th. That number suggests the bank’s operations are on a finely tipped balance over a large cliff.

If the economy continues down, or if it manages nothing but a dead cat bounce, Bank of America stands right in the way of the downtrend. Its vaunted credit card business could suffer massive write offs (expansion of that business came, no doubt, with lesser standards for many new card holders prior to the crash) in a prolonged depression.

Likewise, the mortgage and investing units would likely be hit hard as well.

Of course, the big question mark is CEO Ken Lewis. It was Lewis who masterminded and bungled the acquisition of Merrill Lynch which let the government in the front door in the first place. Lewis’ tough talk now about not needing the government’s money like it was never a factor seem a little bit too much like a youngster trying to change facts that don’t make him look good. Even worse, Lewis seems to have learned little from BAC’s brush with death, bemoaning the government stress test results as an “extreme” scenario. No doubt, Lewis would have considered projections based on the real life economic data of the past two years “extreme” as well if presented in the months before the banking crisis.

All of this comes AFTER the government already allowed the banks to negotiate over the stress tests and caved-in allowing the use of more benign data for the computations. One wonders exactly what scenario Mr. Lewis is willing to accept as not extreme that doesn’t include anything but sunshine and rainbows.

If things go south, expect Bank of America and Mr. Lewis to be behind the curve and struggling to catch up.

Buy, Sell or Short BAC Stock

So, is now the right time to buy or sell Bank of America stock?

The answer depends on several factors. Investors who are confident that the economy’s downturn is ending soon, should see a huge buying opportunity right now, before everyone else decides that they feel good about one of the government’s huge bailout banks.

For investors who see too much optimism regarding the economy’s future, BAC is a huge sell and possibly a great short opportunity.

Further information becomes available by June 8, when the company has to submit its plan to raise the required capital as defined from the stress test. Lewis has publicly declared that they are not redeeming the government’s preferred stock for common stock and that they will not need any more TARP money. Going back on either of these commitments should be a red flag with blinking lights and alarm sirens blaring.

BAC’s ability to raise the capital it needs via stock offerings and converting privately held preferred stock will be a litmus test for investor’s confidence in the bank’s ability to right itself.

Either way, BAC looks like a bumpy ride in the coming months. Maybe a nice options trade might be a little straddle play assuming the prices are bearable.