Goldman Sachs Downgrades Bank of America; Shares Fall 3%

Goldman Sachs GS adjusted its coverage on a number of major financial stocks on Monday. The investment bank upgraded shares of Citigroup C to Buy and downgraded Bank of America BAC to Neutral from Buy. In addition, Goldman removed J.P. Morgan JPM from its Conviction List, but maintained its Buy rating on the stock and upgraded shares of Morgan Stanley MS from Neutral to Conviction List Buy. In addressing Citi and Bank of America, Goldman analysts wrote that while both stocks are trading at similar valuations, Citi has a clearer path to return capital, less execution risk versus BAC, and higher potential earnings power going forward. Goldman Sachs believes that Citi is positioned to implement a dividend of between $0.40 and $0.50 along with share repurchases of $3 billion to $4 billion in the future. They also said that BAC stock appears to be expensive relative to its peers based on near-term earnings expectations. They wrote that with both stocks trading at significant discounts to tangible book value, "we view the risk/reward for C as more compelling given its high growth footprint and lower tail risk from mortgage. In addition, we believe that by 2014 C will generate an ROE of 12% which should drive shares back towards tangible book value." With regard to BAC, the analysts wrote that "while we expect expense saves in 2012/13 to improve profitability, significant de-leveraging in 2011 will limit BAC's longer-term earnings power and it will struggle to earn returns above its cost of capital for the foreseeable future." Goldman is now estimating that BAC can generate earnings power of $1.30, which is down from the $2.00 the firm was projecting in March. In the wake of Goldman's downgrade of BAC and its upgrade of C, the stocks are both trading lower. Bank of America shares have lost 3.29% to $7.05 while Citi is down 2.46% to $30.11. Over the last month, however, both names have been rallying, with BAC notching gains of 27%, while C shares are up 14.52%. Nevertheless, BAC and C continue to trade at extremely depressed levels. Citi has fallen a little less than 95% over the last 5 years while BAC is down more than 86%. One metric that captures investor mistrust and uncertainty in relation to these two names is their price/book ratios. Currently, BAC trades at a price/book ratio of just 0.35 while Citi's ratio is just 0.51. These figures suggest that the stock market is still extremely nervous about the forward looking prospects for the banks, particularly in the event of another downturn. While both stocks are have been experiencing some positive momentum over the last month, it remains unclear whether this will be just another dead cat bounce or if a meaningful turnaround in their share prices is getting underway.
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