BAC-WT - Bank of America Warrants

[shalab]

Overall, it was a plus for BAC and its shareholders with the confidence of WEB. I bet it got a whole lot of new shareholders as well. ;)

 

IMO Brian Moynihan did it because *he* benefits from it, at incredible expense to shareholders.  Moynihan himself gets better job security because Buffett will go on TV and talk about what a great job Moynihan is doing.  Buffett reflexively supports management and boards, so, whenever times get tough Moynihan bought himself someone to diffuse the situation (see comments re: capital mistakes).  What board is going to fire a CEO that Buffett endorsed? 

 

IMO the benefits go to the CEO and the board, while the cost goes to shareholders - what's not to love about that?  And conversely, Buffett makes a fortune while "paying" with a few kind words.  It's like when Nike pays an athlete to endorse some shoe; except in this case, they are paying $15 billion to endorse a stock. 

 

Look if Buffett proposes a deal to you, your answer should almost always be "no."  He's one of the world's richest people because he knows how to under-pay for assets.  So when you start selling the guy assets, you are being fleeced.  I think he'll make $15 billion on the deal, and I don't think he will deliver value to shareholders even close to that. 

 

Frankly, if Moynihan turned him down, I think there's a decent chance he would have bought on the open market - which would have also had a very good return. 

 

I don't really understand the "qualitative benefits" we get from him.  He's not advising the company, he's not facilitating new business.  All he does is say nice things about it periodically which doesn't change anything about the fundamental value of the business. 

 

 

 

 

And for me, the very worst unforced error was the Buffett warrants which is going to transfer billions of dollars of wealth from shareholders to Berkshire.  I basically find this one unforgivable.  Who here wouldn't have taken the same offer from BAC if they had a rights issue under the same terms? 

 

 

I get this, but wasn't there, at the time, a "qualitative" need to increase confidence in BAC that Buffett provided (at a large cost, granted)?

 

That was kind of what I was going to post. 

 

If I were in Moynihan's shoes and I got a call from Buffett I would make the same decision he did at the time.  That kind of offer only comes once.  I just dont know how one could say no.  Call it political goodwill.  How many times have bloggers, seeking alpha contributors, and board members here referenced Buffett in relation to BAc "I wonder what WEB thinks about this or that?".  Buffett told us yesterday, what he thinks, whether he is sincere or not.

 

Xazp, That is really well said.  i dont disagree, and certainly cant imagine what Moynihan was thinking at the time, except he had a better handle on capital conditions at BAc than us.  Maybe he was a bit star struck. 

 

eric, That artcile was great.  Is Mayo the one with the $10 price target?

[wescobrk]

"Is this correct?  I didn't realize that the change in the terms of the preferred was going to benefit "regulatory" capital by the full $5 billion.  He is implying that it will affect Basel III as well.  Perhaps he's obfuscating. "

 

Kilt, I thought I read it was 2.9 billion added to regulatory capital  but that was several weeks ago and I might be wrong.

Also, I thought someone posted they don't get credit until next year as the agreement was after ccar submission.

[sswan11]

Bill Nygren chimes in:

 

http://finance.fortune.cnn.com/2014/05/02/why-a-star-fund-manager-is-bullish-on-bank-of-america-and-apple-buybacks/?source=yahoo_quote

[ERICOPOLY]

"Is this correct?  I didn't realize that the change in the terms of the preferred was going to benefit "regulatory" capital by the full $5 billion.  He is implying that it will affect Basel III as well.  Perhaps he's obfuscating. "

 

Kilt, I thought I read it was 2.9 billion added to regulatory capital  but that was several weeks ago and I might be wrong.

Also, I thought someone posted they don't get credit until next year as the agreement was after ccar submission.

 

This is a quote from the conference call transcript:

 

I also want to remind you that our Tier 1 capital and supplemental leverage ratios will benefit by approximately $2.9 billion in the second quarter of '14 if we receive shareholder approval to amend our Series T, preferred stock.

 

 

[ERICOPOLY]

Bill Nygren chimes in:

 

http://finance.fortune.cnn.com/2014/05/02/why-a-star-fund-manager-is-bullish-on-bank-of-america-and-apple-buybacks/?source=yahoo_quote

 

Wow, look at that photo.  I loved him when he was with Digital Underground.

[peter1234]

Bill Nygren is a terrific investor.

 

However... I am not sure if I would trust his opinions on banks... If I remember correctly, he had Washington Mutual as (one of) his top holdings and lost like 10% or more of his fund on it.

 

;)

[Rabbitisrich]

But that preferred doesn't even count towards Basel 3 capital (which is why we're voting on converting it into Basel 3 capital now).  Why would the regulators insist that BAC strike a deal that didn't benefit Basel 3 capital? 

 

I wonder whether Moynihan and Buffett were even considering Basel at the point of transaction. Given the nature of the risks that would interrupt preferred dividends, the cumulative feature is probably a minor protection. And, correct me if I'm wrong, but the preferreds were issued after regulatory guidance that would describe how they would be written down and converted to equity according to regulatory discretion. Given that the preferreds can be used to exercise the call option, I'm (completely) guessing that Buffett may have just been seeking an additional discount to the call option plus a source of liquidity.

 

But thinking about it from Buffett's view, why would he have the gall to just call up a CEO, who happens to be working on a major deal to exit CCB, and propose this plan? If not coincidence, then was Buffett selling his name? And, if so, why?

[Rabbitisrich]

"Is this correct?  I didn't realize that the change in the terms of the preferred was going to benefit "regulatory" capital by the full $5 billion.  He is implying that it will affect Basel III as well.  Perhaps he's obfuscating. "

 

Kilt, I thought I read it was 2.9 billion added to regulatory capital  but that was several weeks ago and I might be wrong.

Also, I thought someone posted they don't get credit until next year as the agreement was after ccar submission.

 

This is a quote from the conference call transcript:

 

I also want to remind you that our Tier 1 capital and supplemental leverage ratios will benefit by approximately $2.9 billion in the second quarter of '14 if we receive shareholder approval to amend our Series T, preferred stock.

 

Buffett's $5 B probably references the amount of cash exchanged, but BAC recorded it at $2.9 B after discounting $2.1 B for the option value.

[xazp]

I don't think Buffett was selling his name.  I suspect he wanted to buy BAC anyway - strong franchise, deep discount at the time.  So the endorsement would have come for free.  But he decided maybe he could juice that return by negotiating a deal with Moynihan.  So a 30 minute call nets him an additional 6%/year (above buying the stock on the open market), a few hundred million per year. 

 

Talking about star investors:  http://www.sec.gov/Archives/edgar/data/783412/000143774914001834/xslForm13F_X01/rdgit012814.xml

Here's a 13F with ~30% in BAC.  Guess who?

 

Anyway, that 13F suggests to me that Buffett would have bought regardless of the deal.

 

 

But that preferred doesn't even count towards Basel 3 capital (which is why we're voting on converting it into Basel 3 capital now).  Why would the regulators insist that BAC strike a deal that didn't benefit Basel 3 capital? 

 

I wonder whether Moynihan and Buffett were even considering Basel at the point of transaction. Given the nature of the risks that would interrupt preferred dividends, the cumulative feature is probably a minor protection. And, correct me if I'm wrong, but the preferreds were issued after regulatory guidance that would describe how they would be written down and converted to equity according to regulatory discretion. Given that the preferreds can be used to exercise the call option, I'm (completely) guessing that Buffett may have just been seeking an additional discount to the call option plus a source of liquidity.

 

But thinking about it from Buffett's view, why would he have the gall to just call up a CEO, who happens to be working on a major deal to exit CCB, and propose this plan? If not coincidence, then was Buffett selling his name? And, if so, why?

[Kiltacular]

Boardmembers, thanks for all the comments today as well as since the recent stock drop.  The discussion has been excellent with solid points and counterpoints.  I have increased my position.

[xazp]

I think we calculated a rough estimate of $1.50/share in normalized earnings (someone did a pretty good job of this, it wasn't me) if you simply take recent earnings and adjust for all the "one-timers." 

 

I'd like to suggest those normalized earnings are based on cyclically-low NIMs and loan/deposit ratios; meaning there is considerable organic upside when the lending environment returns to normal.  Here's my estimate:

 

BAC 10-K says 100bps parallel shift up in interest rates = $3.2Bn

 

Here are Fed Reserve projections for interest rates:  http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20140319.pdf  (since they set them, the numbers should have some accuracy).  By the end of 2016, they are estimating ST-rates will be up about 2%.  I can't really predict LT rates, but, keeping the spread constant, that would imply about $6.4Bn in extra NIM from margin expansion by 2017. 

 

BAC supplemental information shows they have about $300Bn of assets sitting around earning "nothing" (for example with the Fed).  If you assume that 2/3rds of that eventually gets lent out when they find borrowers, that goes from .25% to say 4.25%.  This implies a further $8Bn in NIM simply from lending 2/3rds of excess reserves at current average consumer rates. 

 

$14.5Bn in pre-tax income = nearly $1/share in eps. 

 

That suggests to me that in an environment of normal interest rates and lending (vs current low interest rates and low loan growth), BAC could earn $2.50/share. 

 

[ERICOPOLY]

BAC supplemental information shows they have about $300Bn of assets sitting around earning "nothing" (for example with the Fed).  If you assume that 2/3rds of that eventually gets lent out when they find borrowers, that goes from .25% to say 4.25%.  This implies a further $8Bn in NIM simply from lending 2/3rds of excess reserves at current average consumer rates. 

 

 

I think if they lend it out, they need to retain more earnings in order to keep regulatory capital ratio happy.

 

How much would that be?  I think it needs to be knocked off the share price given that it no longer becomes "distributable" to shareholders while it's being used to support higher lending.  Otherwise it's sort of double-counting.

[xazp]

I don't think I'm double counting.  Maybe over-counting but let me explain.  To me there are two sources of capital that come virtually for free to BAC (and also C). 

 

First source is the run-off of past bad loans that are delinquent/non paying.  Right now, CRES consumes $23Bn of capital and loses billions of dollars a quarter, and its return on capital is negative.  The risk weights on delinquent/NPAs are very high .  When CRES normalizes to a group that mostly services paying mortgages, I believe a lot of capital will be redeployed into something (say loans) with much lower risk weights.  BAC and C both have a lot of capital tied up in delinquent loans which will eventually be usable as they run those bad loans out of the books. 

 

An alternate way to look at this is simply that CRES has $23Bn of capital.  In 2013 this capital earned a return of -$8.1Bn pre-tax (or -34%).  In the long-run, CRES capital should go way down, and the capital redeployed at 10% or whatever in other business lines.  For a swing of $10Bn+. 

 

Second source is DTAs - about $43Bn of those.  These currently earn 0%, but as they earn their way through, the capital gets again redeployed at 10% or whatever. 

 

DTA alone is around 30% of the firm's total capital.  CRES is about 15% of capital - the two doubtless overlap.  So as DTA runs off, in theory you could increase loans (and every other business line) by 30% - over time of course.  So $900Bn of loans today could increase by $270Bn ... more than what I've suggested (my back-of-the-envelope suggested $200Bn of loans).  And simultaneously you could return 100% of earnings. 

 

 

 

 

BAC supplemental information shows they have about $300Bn of assets sitting around earning "nothing" (for example with the Fed).  If you assume that 2/3rds of that eventually gets lent out when they find borrowers, that goes from .25% to say 4.25%.  This implies a further $8Bn in NIM simply from lending 2/3rds of excess reserves at current average consumer rates. 

 

 

I think if they lend it out, they need to retain more earnings in order to keep regulatory capital ratio happy.

 

How much would that be?  I think it needs to be knocked off the share price given that it no longer becomes "distributable" to shareholders while it's being used to support higher lending.  Otherwise it's sort of double-counting.

[gary17]

xzap, I'm wondering if you know what kind if growth the US needs to see before there's loan growth. What kind of population growth, etc.. and given there's also wells and citi and others slicing the pie.... I haven't done any calcs or guesstimate, but just off the top of my head this seems quite challenging given the current environment. what would cause the US to go into this growth to see it in BAC's top line? I'll do some thinking.

[gary17]

Here's the BAC thread.

 

I spoke to IR this am... the response I got regarding the legal reserve is that it is reassessed on a quarter by quarter basis and she didn't think it was right to simply look at this as BAC missed this 4.9B. she understands how we are doing the math but just didn't think that's how they would look at it. Sounds like pretty weak answer.

[xazp]

Well my starting point is graphs like these:

http://www.creditwritedowns.com/2014/01/bank-reserves-and-the-falling-loan-to-deposit-ratio-at-us-banks.html

 

which show that loans/deposits are usually in lock-step,  until the financial crisis, when they started diverging.  In addition, metrics like consumer interest payments are at multi-decade lows.  So I'm really arguing reversion to the mean.  We are in a phase where lending is less than deposits, but historically, the two are fairly similar. 

 

So, I don't have an answer to why these numbers are at lows, though I've dug up some plausible arguments. 

A) The blog post below argues it is related to QE; so, as the Fed balance sheet contracts (i.e. the "government" balance sheet) you might expect bank loans to grow to take up that hole;

B) David Einhorn (http://www.huffingtonpost.com/david-einhorn/fed-interest-rates_b_1472509.html) argues that because the Fed has announced a prolonged period of low interest rates, no one is motivated to borrow "now" - but will borrow once interest rates start moving up.

C)  Burn-out from the financial crisis (both borrowers and lenders). 

 

Honestly, I am not strong enough at macro to tell if/when loans/deposits will go back to normal, it just seems to me that we're at something like several-decade lows for loans/deposits and when I say that 2/3rds of their reserves get lent out, I'm really just suggesting that we will eventually revert to the mean. 

 

 

xzap, I'm wondering if you know what kind if growth the US needs to see before there's loan growth. What kind of population growth, etc.. and given there's also wells and citi and others slicing the pie.... I haven't done any calcs or guesstimate, but just off the top of my head this seems quite challenging given the current environment. what would cause the US to go into this growth to see it in BAC's top line? I'll do some thinking.

[Uccmal]

Xazp, as counter intuitive as it seems Einhorn's proposal has merit.  Raising interest rates has the effect of making people want to borrow before rates go back to really high levels.  I have noticed this effect in Canada before.  The fed. can always back pedal if it has the opposite effect.  But who am I to argue with the fed....

[Uccmal]

Has anyone else been buying BAC at these levels.  The stock was last at this level  nearly 7 months ago, and prior to that bounced around 13.60 for a half year.  Arguably BAC is safer now at 15 than it was at 13.60 or 14.75 when there were still more unannounced big settlements such as the 9.0 b AIG suit.  More crappy mortgages have run off the books. 

 

The only major suit remaining seems to be the DOJ (dont quote me on this as we dont know for sure). 

[cubsfan]

I don't think Buffett was selling his name.  I suspect he wanted to buy BAC anyway - strong franchise, deep discount at the time.  So the endorsement would have come for free.  But he decided maybe he could juice that return by negotiating a deal with Moynihan.  So a 30 minute call nets him an additional 6%/year (above buying the stock on the open market), a few hundred million per year. 

 

Talking about star investors:  http://www.sec.gov/Archives/edgar/data/783412/000143774914001834/xslForm13F_X01/rdgit012814.xml

Here's a 13F with ~30% in BAC.  Guess who?

 

Anyway, that 13F suggests to me that Buffett would have bought regardless of the deal.

 

 

But that preferred doesn't even count towards Basel 3 capital (which is why we're voting on converting it into Basel 3 capital now).  Why would the regulators insist that BAC strike a deal that didn't benefit Basel 3 capital? 

 

I wonder whether Moynihan and Buffett were even considering Basel at the point of transaction. Given the nature of the risks that would interrupt preferred dividends, the cumulative feature is probably a minor protection. And, correct me if I'm wrong, but the preferreds were issued after regulatory guidance that would describe how they would be written down and converted to equity according to regulatory discretion. Given that the preferreds can be used to exercise the call option, I'm (completely) guessing that Buffett may have just been seeking an additional discount to the call option plus a source of liquidity.

 

But thinking about it from Buffett's view, why would he have the gall to just call up a CEO, who happens to be working on a major deal to exit CCB, and propose this plan? If not coincidence, then was Buffett selling his name? And, if so, why?

 

XAZP - I am a little confused on the link you posted (13F) - this set of holdings detailed on the doc look exactly like the holdings at DJCO.

 

Are you saying these are Buffett's holdings and he is buying BAC common?

[ERICOPOLY]

I just figure it was a bit of one-upmanship between Warren and Charlie.  Warren probably knew Charlie was buying, so he called up Moynihan and got a better deal.  Sort of like a gentleman's competition.  So he was probably grinning a bit at getting a better deal.

[xazp]

It's DJCO.  I was half responding to an earlier post about how Nygren liked BAC.  I think of Munger as a super-investor too, and he's got more BAC (%-wise) than any of these guys. 

 

I have been buying more BAC.  I actually think there are some signs of loan growth coming - via business cap-x spending and credit cards. 

i.e. http://online.wsj.com/news/articles/SB10001424052702303647204579543982494897024

"In the Fed's latest quarterly survey of banks' senior loan officers, the majority of respondents forecast growth in credit-card lending would reach prerecession levels of around 6% by 2016. It grew by less than 1% last year." 

 

I don't think Buffett was selling his name.  I suspect he wanted to buy BAC anyway - strong franchise, deep discount at the time.  So the endorsement would have come for free.  But he decided maybe he could juice that return by negotiating a deal with Moynihan.  So a 30 minute call nets him an additional 6%/year (above buying the stock on the open market), a few hundred million per year. 

 

Talking about star investors:  http://www.sec.gov/Archives/edgar/data/783412/000143774914001834/xslForm13F_X01/rdgit012814.xml

Here's a 13F with ~30% in BAC.  Guess who?

 

Anyway, that 13F suggests to me that Buffett would have bought regardless of the deal.

 

 

But that preferred doesn't even count towards Basel 3 capital (which is why we're voting on converting it into Basel 3 capital now).  Why would the regulators insist that BAC strike a deal that didn't benefit Basel 3 capital? 

 

I wonder whether Moynihan and Buffett were even considering Basel at the point of transaction. Given the nature of the risks that would interrupt preferred dividends, the cumulative feature is probably a minor protection. And, correct me if I'm wrong, but the preferreds were issued after regulatory guidance that would describe how they would be written down and converted to equity according to regulatory discretion. Given that the preferreds can be used to exercise the call option, I'm (completely) guessing that Buffett may have just been seeking an additional discount to the call option plus a source of liquidity.

 

But thinking about it from Buffett's view, why would he have the gall to just call up a CEO, who happens to be working on a major deal to exit CCB, and propose this plan? If not coincidence, then was Buffett selling his name? And, if so, why?

 

XAZP - I am a little confused on the link you posted (13F) - this set of holdings detailed on the doc look exactly like the holdings at DJCO.

 

Are you saying these are Buffett's holdings and he is buying BAC common?

[cubsfan]

Agree - Munger's a super investor too (btw - he was really sharp in Omaha last week).

 

I've never seen a 90 year old with such a quick mind.

 

Thanks for clearing this up - unlike Munger, I am easily confused!

 

I own a ton of common and warrants, so I was overly excited thinking Buffett was diving in.

[xazp]

Munger is great - I actually find his comments more interesting than Buffett's, because Buffett sugar-coats everything.

 

I should say, I think Munger bought these stocks during the financial crisis, so, his ownership of them does not mean he thinks they are severely undervalued now ... But it is interesting to me that Munger bought before Buffett, so it's possible Buffett got the idea from Munger. 

 

 

 

Agree - Munger's a super investor too (btw - he was really sharp in Omaha last week).

 

I've never seen a 90 year old with such a quick mind.

 

Thanks for clearing this up - unlike Munger, I am easily confused!

 

I own a ton of common and warrants, so I was overly excited thinking Buffett was diving in.

[bennycx]

Buffett did the deal to accumulate a large stake in BAC in one go.

If he were to buy it over months he would have gotten a much worse price and he suspects that BAC wouldn't stay that low for a long time for him to accumulate.

[Mephistopheles]

DJCO also owns one or more foreign stocks that are not traded in the U.S. (probably BYD). So the % of BAC in the portfolio is smaller than it looks.