BAC-WT - Bank of America Warrants

[ValueBuff]

I know I have seen some ideas regarding these.  I figured I would create the thread here.

 

The warrant that is most interesting to me is BAC.  The reason is the strike price adjustment for any dividend paid over 0.01$ per share.  At some point, the major US bank will start to repay shareholders.  Either by dividends (falling strike price on warrant) or buybacks (increase EPS) the BAC warrant offer the best bang as it is the only one that is adjusted downwards after 1 cent.

 

Thoughts?

[Ballinvarosig Investors]

Am I the only one who is scared by a Texas Ratio of over 100%?

[Rabbitisrich]

Are you talking about BAC? According to the last 10-Q, they have a Texas ratio of 21%

[SmallCap]

Excuse my ignorance but what do you mean by a Texas ratio?

[biaggio]

Excuse my ignorance but what do you mean by a Texas ratio?

 

I did not know either, but thanks to google search:

 

The Texas ratio is a measure of a bank's credit troubles. Developed by Gerard Cassidy and others at RBC Capital Markets, it is calculated by dividing the value of the lender's non-performing assets (Non performing loans + Real Estate Owned) by the sum of its tangible common equity capital and loan loss reserves.

In analyzing Texas banks during the early 1980s recession, Cassidy noted that banks tended to fail when this ratio reached 1:1, or 100%. He noted a similar pattern among New England banks during the recession of the early 1990s.

[SmallCap]

Thanks, that helps a lot.

[Uccmal]

I have looked at and own the warrants for BAC and WFC.  I have reviewed the prospecti for each of these companies.  I haven't looked further into warrants from other US banks.  Part of the reason for this is that I have followed both companies since at least the credit crisis and have used their stores everywhere over the years.

 

The warrants allow me to buy BAC at 13.30.  So for an average of about $6.50 so far I get to buy BAC some time by January 2019 for 13.30.  Right now the break even price would be 13.30 + 6.50 = 19.80.  I would recoup some money with the stock price somewhere between $14.00 and the 19.80. 

 

Here are the problems I see with investing in BAC, warrants or common:

1) It is not really clear, and in fact, nearly incomprehensible, as to what may still be lurking on their balance sheet.

2) The stock could implode due to bad banking practices as in observation 1)

3) The bank could be forced into asset sales to bolster its balance sheet at some point in the future reducing its book value.

4) Regulation could wipe out profitability for years going forward. 

5) As per number 1 - BV could be vastly inflated due to toxic waste on the balance sheet.

 

 

[Uccmal]

The flip side of the negative outlook is the following:

 

1) Most of what is dangerous on BACs balance sheet is probably well known and visible now. 

2) BAC was a go to bank for the US government when they needed someone to take Merril Lynch private

3) Their capital position appears strong at this point in time and their operating earnings appear to be improving. 

4) They are already taking write downs related to regulatory changes with regards to fee income. 

5) Regulation will have some short term effect on profitability but I am quite confident that the big banks will find ways to make money hitherto unknown.

6) Mortage securities - someone mentioned on the other thread that we are now fighting the last battle.  I tend to agree.  There is little chance of BAC losing 50B on a re-buy scenario. 

 

So looking at the stock and the warrants.  A return to book value, assumming some percentage of impairment brings the stock price today up to say $17.  Growth of 10% average in earnings over the next 9 years brings me to a price of $34.00.  That brings the price of my warrants in 9 years to about $20.00.  6.50 to $20.00 in 9 years is not a bad return.  Should they increase the dividend at all along the way then my returns will be greater than that.  On a conservative basis I estimate that the returns on the warrants should be 15% per year or greater. 

 

[Guest Bronco]

Uccmal - not saying either way, but I believe BAC trades 2013 leaps.  Has anyone here analyzed the near the money leap calls as a better % gainer play?

 

-Dan

[Ravi]

Did you think about the repurchase risk of buying back of the bad loans they originated including from country wide from Fannie/Freddie and other investors. This is a serious risk as some other lenders are already purchasing back.

[RRJ]

Uccmal,

 

Thanks.  This was almost exactly my own analysis.  The only other thing I'd add is that I figure with the BAC warrants (which I don't own yet, as I like WFC as a bank and culture much more), they are likely to raise the dividend back up, and anything above $.01 per quarter is subtracted from the strike price.  If, in 2012, they go to a 2% dividend yield on today's price (of around $12.00 per share), then raise the dividend 5% per year, you get dividends of roughly $.24, $.25, .26, .27, .28 and .30 and .31 in 2018.  Strike price is reduced each year by total annual dividend minus $.04.  That's a cumulative reduction in the strike price of $1.62, give or take on these assumptions, which I think are conservative.

 

This gives an adjusted strike price of $11.68, or just above where BAC trades at today ($11.43 as of 3:50 pm).  So your warrant cost of $6.00 buys you essentially all the upside in B of A's common from today's price through 2018.  From this low valuation point, I like those odds, but I do see far more risk in B of A than in Wells, largely the risks you list.  All in all, I see more risk than Wells due to lack of discipline, inferior management (which is amplified in banking just as in insurance), and not as good a possible upside.  I'll probably pass, but it's likely to work out okay.   

 

 

[biaggio]

" I estimate that the returns on the warrants should be 15% per year or greater"

 

Warrants seem like a better deal than the common.

 

Would 15% ( it may be more) per year be enough return for perceived risk you may be taking?

[ValueBuff]

the only risk is B of A not being above the strike+warrant cost.  IT will be around, I think the US gov. has proven that.

 

To me, what makes these things attractive, especially the B of A, is the dividends come off the strike.  In B of A's case, it is the only one with the 0.01$ limit.  I think the WFC warrants are around 0.32-0.34$, than strike price drops.

[SmallCap]

Does anyone know where I can find the dividend policy for each of the tarp warrants? I know what it is for BAC and WFC but can't find it for the others.

 

Also does anyone know what happens to these warrants in change of control or dilution of equity situations?

 

SmallCap

[Uccmal]

Does anyone know where I can find the dividend policy for each of the tarp warrants? I know what it is for BAC and WFC but can't find it for the others.

 

Also does anyone know what happens to these warrants in change of control or dilution of equity situations?

 

i) no

ii) The Warrants are adjusted accordingly to keep up with changes.  I would think a change of control for BAC or WFC is unlikely, and I cant speak to the others.

 

Valuebuff, I would think the dividend increase with WFC is just as likely, if not more so.  I guess a case could be made that the dividend for BAC has some catch-up potential.   

[ERICOPOLY]

Uccmal - not saying either way, but I believe BAC trades 2013 leaps.  Has anyone here analyzed the near the money leap calls as a better % gainer play?

 

-Dan

 

This thread got me interested and I bought some BAC warrants on Thursday and Friday.

 

I thought about those 2013 leaps.  Decided to go with the warrants given it's the only place I can get long term leverage with no financing risk for 8.25 years.  Someplace else in my portfolio I'll buy some 2013 calls on another name.

 

This gives me diversification of maturities.

[ValueBuff]

Does anyone know where I can find the dividend policy for each of the tarp warrants? I know what it is for BAC and WFC but can't find it for the others.

 

Also does anyone know what happens to these warrants in change of control or dilution of equity situations?

 

i) no

ii) The Warrants are adjusted accordingly to keep up with changes.  I would think a change of control for BAC or WFC is unlikely, and I cant speak to the others.

 

Valuebuff, I would think the dividend increase with WFC is just as likely, if not more so.  I guess a case could be made that the dividend for BAC has some catch-up potential.   

 

 

 

I do agree with you that WFC has a better potential to increase the dividend over BAC.  However, will WFC raise it by more than 0.32$ in order to get the drop in strike price? That i do not know.

 

 

I would rather own the WFC common and the BAC warrants

[biaggio]

John Paulson: How Are You Calculating Intrinsic Value For Bank Of America?

 

http://www.gurufocus.com/news.php?id=110254

[pilaniman]

I own BAC and have been acquiring it since April for a fund I manage and yes, I am down so far. I invest with 3+yr horizon so what I say next should be viewed with that time horizon in mind.

(i) I NEVER respected the prior CEO given all the acquisitions he had done over ten years and destroyed the franchise value. Among all the large banks, I got most positive on BAC with the arrival of new CEO as he comes from a strong pedigree - Bank of Boston had a solid track record and I give him credit for being part of that success story. If you read the WSJ story around the time he became the CEO, he was never the first choice. Therefore, he has something to prove and I like a 'hungry' CEO. It did not surprise me that he took all these write-off – after all it's all the goodwill Ken built from the MBNA acquisition and other bone-headed deals. It is not uncommon for new guy to clean the balance sheet and take charges – it seems almost a rite of passage in the corner suite. I also like the fact that the board is completely revamped and the new CFO has been through several turnarounds. Mr. Moynihan seems to be surrounding himself with a competent professional team. As Buffett has said before (and someone else mentioned it on this thread), in the financials - banks, insurance, etc. - one has to be very comfortable with the CEO. I also like his strategy of changing the rules around checking accounts etc. to drive customer loyalty rather than stuffing them with unnecessary surcharges if there balances run low. All in all, Mr. Moynihan gets A in my book so far.

 

(ii) ML franchise continues to hum along fine. I was looking at the Dimon's presentation recently and was surprised to see that ML rates among top five banks in all key IB rankings. It's also good to know we have an ex-GS guy running the joint.

 

(iii) Countrywide business line is an issue but I think the Branch Hill presentation is more noise than substance. I doubt if Fed will take down a core 'too big to fail' bank at this juncture in the economic cycle given what they have to do on the QE2 front and the general economic malaise they are dealing with. It is common knowledge that credit losses have peaked so the only risk is the put-backs that Fannie/Freddie or the private investors will execute and whether BAC has the balance sheet to absorb those losses from countrywide business.

(iv) It will be interesting to see if they start losing deposits or not and how the customers respond to the new strategy. I think majority of the regulatory headwinds are known and the only unknown is how the long-term profitability is impacted from CARD Act and other new regulations like Basel III, etc.

(iv) From a quantitative standpoint, they are trading below tangible BV - my favorite valuation metric for banks and the business is generating a low ROA - my favorite operating benchmark. Good banks have ROA of over 1% and currently BAC is at .25% or so. Clearly, there is lot of room to improve execution and my assessment is that the CEO is headed in the right direction. Good banks generally trade at north of 2.0x TBV (e.g. USB is at 2.5x TBV) and if BAC continue to grow its earnings, it will get a 2 handle in due course.

Overall, it seems to me there is more upside here than any other large bank in the US if one is patient and monitors how the new strategy unfolds. MOST IMPORTANTLY, the downside is very limited at the current price level.

 

[biaggio]

http://www.forbes.com/2010/09/24/citi-goldman-sachs-bove-intelligent-investing-video.html

 

Interview with Dick Bove-overview of banking industry, bank reform, etc

 

-predicts a lot of takeovers in 2011

-talks about concentration of assets, mortgage origination amongst 3 players

-he's never seen banks so cheap. Cash on their balance sheets, like in the 1930's. Largest discount to BV.

-sounds like large banks have advantage over smaller ones, who will get taken out

 

I thought it was good info for someone like myself who has limited knowledge of banking industry.

 

Also,

 

http://www.gurufocus.com/StockBuy.php?symbol=BAC

 

A lot of insider buying in August + also impressive buys by various "guru's".

 

Biggest argument against buying BAC, WFC, etc is that one does not know what's on their balance sheet i.e. you really don t know what you re buying.

 

Is it wise to assume that their balance sheets have been thoroughly "washed out" of toxic assets by the actions of these insiders + big investors who have been buying in? Even WEB as a small position in BAC.

[stahleyp]

There is an article in Barron's this week about the TARP issues, if anyone wants further background. Not much if anything new for reads of the forum, though.

[philassor]

There is an article in Barron's this week about the TARP issues, if anyone wants further background. Not much if anything new for reads of the forum, though.

 

Here is the article:

 

http://online.barrons.com/article/SB50001424053111903697804575574241608256292.html

 

Also regarding WEB he was quick to disassociate himself from the BAC investment ( it was a Simpson pick). Berkshire only owns about 50 million dollars worth of BAC and it represents 0.15% of the stock portfolio.

 

This being said I would think that at the current price the upside looks much more probable than the downside and I too have the itch to buy.

[ERICOPOLY]

Uccmal - not saying either way, but I believe BAC trades 2013 leaps.  Has anyone here analyzed the near the money leap calls as a better % gainer play?

 

-Dan

 

This thread got me interested and I bought some BAC warrants on Thursday and Friday.

 

I thought about those 2013 leaps.  Decided to go with the warrants given it's the only place I can get long term leverage with no financing risk for 8.25 years.  Someplace else in my portfolio I'll buy some 2013 calls on another name.

 

This gives me diversification of maturities.

 

I have started to contradict myself now.  I'm keeping the warrants but I'm adding some $10 strike 2013 calls.  They break even at $13.65, and tangible book value is nearly $13 today.  I used margin to buy the calls (not a dangerous amount of margin).  

 

I figure by 2013 the tangible book value will be higher than $13.65, so mentally I'm writing this down as an investment two years from now below tangible book value.  By then hopefully I will have the cash to take delivery if that is necessary -- from trimming other investments like SSW which should have worked out by then.

 

So this is sort of like staking a claim for what I can reinvest in two years from now.  

 

Downside risk... don't you think they could easily raise $10b to $20b of equity capital at current prices if it comes to that? 10% or 20% dilution isn't exactly going to make the shares worthless.  Aside from this repurchase risk, BofA shares were trading much higher than today for most of the year, and two years from now you'd be adding accrued earnings and a brighter outlook as they'd have shed another two years worth of bad loans and added two more years of good ones.  

 

 

 

[ERICOPOLY]

There is some news here about the dividend policy -- see page 25:

 

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9Njg5MDV8Q2hpbGRJRD0tMXxUeXBlPTM=&t=1

 

They state that they want to pay out about 30% on trailing earnings as a dividend.  They do not want to do acquisitions.  They plan to use the rest of the excess capital for share repurchases and special dividends.

 

Thus far in 2010, their tangible common equity has grown by 15% -- not bad for 9 months.  That's $17b.

 

 

 

 

[stahleyp]

Eric,

 

I appreciate your posts. You use very good logic and I'm glad you post here. Just wanted to let you know. You've also changed my views a bit about risk. I especially liked it when you were discussing investing in something with a huge return, ie fairfax options. From my view, you said one should look at the dollar amount for an investment should be view as basically the time it took to save, rather than the sheer dollar amount. I liked that a lot, so thanks for being a great member of the board! :)