Barron's(10/25) Could BofA Shares Fall To $2.50?
Oct 23 at 00:03
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By Steven M. Sears
(From BARRON'S)
Bank of America's mortgage woes could continue to depress the banking
giant's stock for years to come. At least that's what some high-level investors
are telling us through their trading activity.
Just a few weeks ago, Bank of America (ticker: BAC) seemed ready to emerge
from that special funk that holds back stocks with complicated investment
stories, but now the bank's future prospects are a center-stage concern amid
unease about the legality of many home foreclosures, as well as the asset
quality of its mortgages.
"Bank of America is the market's whipping boy. It is the poster child for
the foreclosure mess," said a senior trader at a major firm, requesting
anonymity.
In the options market, where sophisticated investors reveal their
thoughts, a dour picture is emerging.
On Friday, an investor whose identity is unknown bought 160,000 November
$10 puts paying 12 cents a contract when the stock was at $11.48. The
order was shopped by GFI, an interdealer broker, according to a trader who was
called about the order. The massive put-purchase trade attracted attention
across the stock, options and bond markets, and set tongues wagging about why
someone would buy puts equivalent to 16 million shares that expire Nov. 19. The
trade was probably linked with stock, and serves to hedge a major position.
According to trading patterns, some options traders are betting that
BofA's $ 11 stock could fall to $2.50 by 2013. Indeed, its $2.50 puts that
expire in January 2013 have been actively traded since Tuesday. Investors buy
put contracts if they think the stock will fall in value.
In the current session, the action has extended to $2.50 puts that
expire in January 2012. These puts are probably little more than speculative
trades, but they are telltale signs of the depth of concern that many investors
have about BofA's stock.
The story is also told by changes in the outstanding positions.
Bank of America's November $12 puts, which increase in value as the
stock declines ever deeper below $12, remain unusually active. Open interest
on the November $12 puts increased Tuesday by almost 70,000 contracts,
bringing total open interest to about 360,000 contracts.
Indeed, put options remain unusually active across all strikes and
expirations listed for Bank of America.
In the latest round of allegations against the bank company, Pimco,
BlackRock (BLK), and the Federal Reserve Bank of New York have essentially
accused Bank of America of selling them $47 billion of mortgage-backed
securities laden with enough bad mortgages to diminish the profitability of the
investments. (For one analyst's take on this situation, see the second item in
this week's Market Watch sampling, page M11.)
True or not, such accusations are taken seriously in the markets because
institutional investors always fear banks use their advantages as major dealers
who control the markets to unload bad financial products that they themselves do
not want to inventory. Even worse, this accusation against Bank of America
resurrects lingering investor fears that Bank of America's 2008 purchase of
Countrywide Financial for $4.1 billion has coupled the fortunes of the
Charlotte, N.C., bank to a hard-to-evaluate financial mess.
While initial media reports indicate that BofA has been asked to buy back
up to $47 billion in mortgage securities, a person close to the money managers
said that was premature. "We want to know if improper loans were securitized,"
this person said. "At this point, it is just basic due diligence."
So far, BofA has reportedly rebuffed requests that it repurchase the
securitized mortgages. But that counts for little in the markets. Until the
matter is settled, Bank of America will trade like a litigation stock. News
headlines will heavily influence options and stock trading. The next few weeks
could be tough even if the speculators playing for a snapback in the stock price
manage to make some money.
In the parlance of trading, Bank of America has "headline risk." The stock
will make sharp moves in reaction to the headlines on news stories. And the
headlines will come. The banking industry is accused of relying on shoddy home-
foreclosure practices. Congress is planning hearings, which many in the markets
know -- often from personal experience -- are little more than populist witch-
hunts good for intraday trading volatility.
Inquiries with much more impact could come in the form of investigations
by state attorneys general trying to determine if mortgage lenders violated
state laws.
Already, many sophisticated investors have reached a guilty verdict on
Bank of America as evidenced by unusually robust trading in Bank of America's
bearish options. On Tuesday, when the bank reported disappointing earnings,
1.027 million options, or more than three times average daily volume, traded. On
Wednesday, trading volumes remained 1.6 times normal and investor pessimism was
still robust, suggesting that Mortgagegate still compels more investors and
traders to prepare for Bank of America's stock to continue to slide down the
proverbial slope of hope reserved for Wall Street's most troubled companies.
Bank of America's stock has declined 22% this year, compared with a 9%
decline for JPMorgan Chase (JPM) and a 24% gain for Citigroup (C), the financial
sector's former problem child.
With Bank of America's stock trading at a 52-week low, investors continue
to stockpile defensive put options that will increase in value if BofA's stock
falls further. The November $10 and $12 puts remain widely held, and in
demand. Investors are defraying the price of buying puts by selling bullish
calls. They are using money received from selling calls -- an indication the
stock is not expected to rise -- to buy bearish puts.
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