ERICOPOLY

Here is the exchange from the Q4 conference call: James Mitchel - Buckingham Research: Just a couple of quick follow-up on your Basel 3 Tier 1 common, the standardized versus advanced, you have I guess almost a 90 basis point difference. Some of your large bank peers are closer to a 10 basis point difference. Can you help us think about why you have such a large gap between the standardized and advanced? Bruce R. Thompson - CFO: The first think I would say is that generally we would expect that gap to narrow over time, but as you look at the actual content of it I think that the biggest reason that you have is just given the percentage in some of our commercial loan balances that we have relative to our peers that under Basel 3 advanced get impacted significantly based on the actual credit quality where when you got to standardized that's just 100%. So I think you've got the first thing is you do have some of that activity or difference between the two metrics. And then I would say that the second thing is that we still do have some assets that under Basel 3 standardized do get some fairly heavy risk weightings that we will continue to work off over the next couple of years. So there's no question relative to what we've seen out we're a little bit wider. I think those are a couple of the differences and as I say I'd expect over the course of the next 12 to 18 months you'll see that gap tighten.

I think it was on the Q4 conference call that they stated the number produced under the "standard" method would converge with that of the "advanced" method over time (so the "standard" figure will improve at a rate in excess of what you get merely by retaining earnings). BAC is relatively unique among their peers with regards to the size of the gap... Said differently, over time the normalized figure produced under the "standard" method will move closer to the number produced under the "advanced" method. Meanwhile, they are being held to the 9.3% level produced by the "standard" method. Some of their peers are allowed to use the "advanced" method presently. It's a 60 basis point penalty versus the 9.9%, so that's roughly $8.5 billion of capital tied up for the moment until they either get permission to use the "advanced" method, or until the two naturally converge over time.

$18b released from getting the "disallowed DTA" lifted +$27b of tax asset benefits =$45b total in "extras" That's a total of $4 per share (based on 11.3 billion shares). So BAC could in theory (based on $1.80 EPS) be valued at 10x-12x $1.80 (plus $4 on top of that). Or $22-$25.60. The $4 in "extras" need to be discounted somewhat to account for the time value of money (you don't get all of that tax benefit immediately, you have to wait for it to come in with earnings). So perhaps knock as much as $1 off that perhaps and only count it as $3 in extra goodies.

However... Let's suppose hypothetically that the DTA penalty were to be immediately lifted today (rules changed overnight). Could they really return $18b or would that throw a wrench into the new leverage ratio rules? Do they have an opportunity to return $18b and still keep the leverage ratio from slipping below the 6% and 5% thresholds? Is that just an easy matter of shuffling some assets around to keep the total leverage in check? For example, selling down some low-yield assets?

This is pretty cool the way you explained it. I guess I've heard this sort of explanation in chunks before but hadn't made the full connection with the CCAR process and how it affects capital return. This has (obviously) led them to the situation where they have to hold more capital upfront if they can't get credit for an expanding DTA under simulated stress. So in summary if they really can offset all of their income with the DTA then we've got perhaps about 3 years of tax-free earnings ahead. To sweeten it, towards the end of that period they start getting that "disallowed DTA" penalty lifted during CCAR. So the capital returned over 3 years in theory could be at least as high as all of their pre-tax income, plus another $18b on top of that as the DTA penalty is lifted.

This was from the conference call. Can anyone explain this better in plain English? It sounds like they have an operational risk penalty to their risk weighted assets, and in some cases it's for business activities that they no longer engage in -- they are included in a time series and you sort of have to wait for the data from those past activities to run off (out of the time series). Pretty lame way to get penalized. Marty Mosby - Guggenheim: Three questions, one is operational risk, you talked about that now represents about 25% of your risk-weighted asset, and doing that in the past, that is very sticky. How do you think you can manage around that amount of capital just being trapped and in fact of all of these past settlements that you've had to kind of live through? Bruce R. Thompson - CFO: Your point Marty is a good one, which is that the operational risk models are based on a fairly long time period as we look at it. One of the things that we do continue to try to discuss and stress is that a lot of those operational risk losses are with respect to activities that we no longer engage and have no intention to engage. So, there are some of that dialogs that continue, but your point which is a fair one, is that the time series are fairly long and it will remain out there until the data runs out. I wish there was more that I can say, but your point is a fair one.

Bruce's comments from 2011 are fun to read three years after the fact: Given the fact that they’re not going to pay taxes, they’ll probably buy back all the stock in five years. Great, by the time the 2016 LEAPS expire, there won't be any shares left. So how do we exercise the options for shares in that case? Is that why he likes the warrants instead?

Today, the 2013 AR says they have $32.356b net deferred tax assets (net of deferred tax liabilities). I'm on page 251: http://media.corporate-ir.net/media_files/IROL/71/71595/AR2013.pdf Also note that page 251 claims that the tax credits are in part comprised of $5.384b in foreign tax credit. I believe that foreign tax credit just recognizes things like taxes already paid in the UK and elsewhere -- it will just offset US tax income if that already-taxed money is brought onshore into the US. So it's a pretty worthless exercise to put a value on that -- because if the money is ever brought onshore it will create additional tax payments since the US tax rate is higher. My bet is that the money never comes back onshore unless the US lowers it's tax rates. So, I think at the very least you need to strip out the foreign tax credit of $5.384b. That would leave you with $26.972b in net deferred tax assets after ignoring the $5.384b of foreign tax credit. That's almost getting it down to (but not quite) 30% of $80b (getting close to Bruce's number that you cited although I take it the data point is now 3 years old).

I only see $10.967b of NOLs on page 253: http://media.corporate-ir.net/media_files/IROL/71/71595/AR2013.pdf It's $3.061b in the US and $7.417b in the UK, and 489 million elsewhere. Combined, $10.967b. It's my understanding that these NOLs are what shield their operating income from taxation. Once they earn another $10b or so in the US (at 30% tax rate), they should be back to paying taxes in the US again, correct? It seems that if the US NOL is worth $3.061b, then it shields roughly $10b of US operating income if tax rate is 30%.

Here is a question from 10,000 ft level: How can it shield $125B in pre-tax income if they only lost $2.2bn in 2009 (net income) and that was their only losing year? Those are some pretty small losses compared to the value you are saying these things are worth. Actually, they're small compared to how much I'm saying they're worth! My number came from one of their 10-Q reports from a year or so ago -- I wanted to know how much capital was being disallowed because of the DTA... Somewhere in the report it showed how much capital was disallowed for the DTA portion -- it was something around $14billion or so worth of disallowed B3 capital. Or it cost them roughly 100bps of B3 capital. So I'm just guessing that they've used up about $2b or so since then and now it would only be ballpark around $12 billion. My reasoning is the amount that is "disallowed" is the amount that can be returned to shareholders once it is unlocked. BTW: I am rather an amateur, so don't take it as an insult if I'm way off base and you are dead-on right. Please somebody explain it to me if you know better.

However, the DTA value is a "one time" thing. In two years, it will be all used up. So you can't put a multiple on that. I forget exactly where the DTA is these days, but I remember it to be somewhere around $12b (too lazy to look it up). So about $1.06 a share. I think the way to go about it is to either assume the DTA will go towards "unexpected" legal surprises, or it should just be added on top of your intrinsic fair market value that based on net income. So if net income were $1.70 per share, you would say it's worth $20.40 per share at 12x multiple. Then you might say it's $21.46 after adding in the DTA (pretending there will be no more legal surprises).

"So, let's say BAC can earn $1.70, that implies capital generation (due to DTA) of $2.20." $2.42 if they earn $1.70 at 30% tax rate. 10% more than you wrote.

And then if you play a game like.... what if the Second Great Depression really does come along? How much can you lose on a $13.30 strike warrant by January 2016 if you are paying $8 for it today? Okay, you can in fact lose $8. But if the stock is at $12, let's just say you lose 50% to 60%. Something like that. It will only have 3 years left on it by then... it will be priced similarly to LEAPS as there will be no special attraction left. No more mystique at that point. So you can lose a ton on the warrant. But you can only lose $2.12 on the $17 strike 2016 put (plus interest on the loan). So... well that just highlights how risky the warrant is versus the safer LEAPS strategy. Price of the leverage is the same (roughly). Safety level is not the same due to the wide range between strike prices.

Suppose you leveraged up with common stock using portfolio margin, and you hedged with the $17 strike 2016 puts ($2.97 at the "ask"). That would cost 10% a year for the put. You then pay margin interest (very cheap at IB). However, that's a $17 strike put . Considerably more price protection than a $13.30 strike put! There should be a wide difference in leverage cost for a $17 strike put versus a $13.30 strike put. But there isn't. It's a very narrow spread. Actually, the 1 cent dividend threshold on the warrants costs 30 bps per year. IB charges something like 50 or 60 bps for margin interest on large loans -- so... in cost the $17 strike 2016 put strategy is nearly identical to going with the warrant. Bizarre.

This appears to suggest the market likes the long term prospect of BAC. Maybe better to buy commons ? Is Mr. Market a wife beater? Look at the chart of BAC stock price last month or two. Just expressing love?

I just can't believe the cost of leverage is over 10% a year again in the $13.30 strike BAC warrants. So weird. Such a bad deal.

Agree with that. I think there is a decent shot of there being $1.80 in net income buried under the expenses, that will emerge towards the tail end of 2015. So the upside from here is based on a multiple of that. $18-$21.60 (at 10x-12x). And then discounted a bit to account for the ongoing frustration of the Fed hiking unofficial capital requirements at their will (for example, this year the Fed has got them squirreling away another $10b roughly as the excess amount they should be generating but aren't allowed to return). I allocate the $10+b DTA value to continued legal reserve surprises.

This is the question I'm always grappling with. I would think the multiple would be higher than historical, given the relative safety of the business these days (higher capital ratios, less leverage). Oh well, no premium given for safety so far.

What's up with the 200 million dollar "tax benefit"? There was a 500 million dollar pre-tax loss, but it gets reduced by 40% to only 300 million (because of the tax benefit). Is that something you need to adjust for? I take it there should be some sort of tax benefit when you report a loss, but it's 40% of the total.

Yeah, but in that alternate world (and in this one) they benefitted from the deal with Buffett -- which was a one-time thing in Q1 that won't happen again. Anyhow, a $6b charge is only like $4.2b after tax, which is only 37 cents per share. As long as their comments from just two months ago can be relied upon, and this is really $6b out of the remaining $6.1b of charges... ohhh.... forget it :-[ So best guess, is it another $6b?

I couldn't quite work out the math on that. I got that 35 cent number as well... but doesn't that assume something like a 40% tax rate? Seems too high.

Did Buffett agree to amend the terms of the warrants/preferred deal only under the condition that they do a "big bath" and boost the legal reserve once and for all? Or is it going to be a continuation of abuse to our trust -- tell us at most another $6.1b, then take a $6b charge, then tell us just another $5b, then another $5b charge, then tell us just $3b more, then $3b charge. I think I know why the stock reaction is negative today. However, the stock hasn't been this low for like... 48 hours. So it's hardly new territory if put in recent historical context.

Here is the quote: Bank of America Corp., the second-biggest U.S. lender, disclosed new probes into its mortgage and foreign-exchange businesses and boosted an estimate of potential legal losses by 20 percent to $6.1 billion. http://www.bloomberg.com/news/2014-02-25/bofa-discloses-new-probes-amid-surge-in-possible-legal-costs.html And so of course, that means there is only potential for another 100 million now right ;) After all, they just reported $6b in Q1. So that leaves... 100 million. And it's been less than 2 months.

In the last 10-Q they talked about potentially being under-reserved for legal issues. Somewhere in the realm of $5b or $6b. So now that they've hit the $6b number in this quarter alone, I'm interested in what the next 10-Q says on the topic.

a certified Woman Owned Enterprise How do we know for sure?