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Low Stress For Bank Of America Corporation (BAC) Until ZIRP Dies

 December 05, 2012 09:35 AM

(By Rich Bieglmeier) The banking industry is on the rebound. According to the FDIC, the sector enjoyed its biggest quarterly earnings gains in six-years. Banks earned 6.6% more in Q3 2012 than during the same timeframe a year ago, totaling $37.6 billion in the third quarter. As the need to set aside money for bad loans diminishes, there is a corresponding rise in profits.

FDIC says nearly 60% of banks announced better earnings than a year ago, and the number of banks in danger slid to a three-year low. The industry is on the rebound.

The improvement in the industry's health means that most banks will have an easy time passing the U.S. Federal Reserve stress test when papers are due in January, 2013. Bank of America Corporation's (BAC) Chief Executive Brian Moynihan says the too-big-to-fail (TBTF) institution's ability to produce a "recurring earnings stream" will be a key factor in the upcoming report.

[Related -Bank Stocks: The Misbegottenness of the Volcker Rule Truly Knows No Bounds]

At the end of the third quarter, BAC's Tier 1 common capital ratio is 8.97%, which is higher than the 8.5% target Ben Bernanke and company will probably institute. Wall Street will look to see if the bank has enough capital to increase its penny per share dividend to buy shares back.

Moynihan made it clear he wants to return capital to shareholder saying, "It's pretty clear we've got the capital we need, and I think now it's just a question of returning [value to shareholders]."  iStock believes a dividend hike is likely, albeit a small one.

[Related -JPMorgan Chase & Co. (JPM): Capital Concerns Should Ease In 2014]

While things are clearly on the upswing in the industry, trouble still lurks. The Federal Reserves' unending zero interest rate policy (ZIRP) is locking banks into mortgage loans that will hurt profits when interest rates rise. A 3% loan won't look so good or be marketable without dropping in value against a 7%er.

The head honcho at BAC told an investors conference in New York the financial major expects to make more loans during 2012's fourth-quarter than the $21.6 last year.  Management is aware of the risks that come along with more loans in the current ZIRP environment. As result, BAC is trying to keep its duration at "a couple--two and a half years or so" by hedging with derivatives. Oh no, not again.

Chairman Bernanke and his FOMC minutes have made it beyond clear that interest rates aren't going higher until we can no longer afford gas or groceries or until unemployment falls below 9%. So, it might be a while before rising rates hit the banking industry's balance sheets.

From here to there, Bank of America Corporation's (BAC) and the sector should continue to see profits improve. Perhaps, the lack of a fiscal cliff parachute will sidetrack profits for six months, maybe more, maybe less, but after the initial shock wears off, the Fed driven gravy train should get back on schedule.

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