BAC-WT - Bank of America Warrants

[alertmeipp]

It's not just mortgages, when house prices correct, many sectors will get impacted, consumer spending will be lower, many are using HELOC for things like cars, appliances, vacation.

 

Unemployment will jump, all loan types will be impacted.

 

 

 

[xazp]

I did not know that.  Do you know if Canadian expense ratios are higher than the US as a result?  Or perhaps in Canada they pay their execs less so it evens out?

 

I think you raise a very reasonable point though.  BAC used to be a deep value stock - if normalized earnings are $2/share, you could buy it at 3x.  Today, 7.5x which is cheap but not excessively so.  The next leg up, if we have it, is either going to be in earnings beyond $2/share or because they can return a whole lot more capital than they have so far. 

 

 

 

That is correct.  They are protected by ownership legislation.  In return, they employ a certain number of people.  Operational socialism.

[ERICOPOLY]

Royal Bank of Canada (RY) trades at:

2.5x book value

13.7x PE ratio

 

Okay, so apply that PE multiple to BAC with $1.80 per share of earnings:

 

$24.66 share price at 13.7x PE ratio

1.17x book value

 

So one banks' 2.5x book value is another banks' 1.17x book value.

 

Investors care primarily about the earnings.

 

Agree and disagree.  Investors care about earnings, but earnings go to increasing Bv/share and/or payouts. 

 

As I said Canadian Banks are protected and are therefore more profitable than Us banks.  They also universally pay out higher dividends.  So, using your argument, if Ry trades at 13.7 x earnings, BAC is maybe only worth 9x or 10 x earnings which gets us to 1.50 x 10= 15.00, or 18 under your scenario.  Unless I see rapid improvement in the business from here on, I will be exiting most of my leap poisitions, and wont renew them this fall. 

 

I should probably sell all my Bac and invest it all in the Canadian Banks, and be done with it.  With dividends they double every 4-5 years or so.

 

Yep, I figure it's worth maybe 10x earnings at the low multiple, maybe more.  So $18 perhaps at the base.  Management said last fall that they could do 13%-14% ROTE in this interest rate environment.  So that would put it at $19.60 at 10x earnings and 14% ROTE.  Add in earnings and you get a value around $20-$22 perhaps by Jan 2016.  Something like that.  Perhaps it only trades at $17 or $18 by then. 

 

I'm stuck with it because of taxes and the upside to those numbers is perfectly fine by me.  No point selling.  I dumped 100% of it in my RothIRAs when it was over $17 early this year.

 

I started off investing hoping I could make 10% a year.  Somehow the odyssey changed course, but now I'm back to 10% a year goals again.

 

[kevin4u2]

I would echo liberty's comments and add Canadian banks are more highly leveraged hence the higher ROE's.  CIBC has a pile of unsecured consumer credit.  When the commodity cycle turns, incomes will fall and housing prices will fall. That is why Fairfax is short the TSX 60.  Below is an interesting quote I just read about the Canadian banks:

 

Interesting: 4 of the 5 largest Canadian Bank CEOs have retired in the last year…

 

McCaughey is the–not kidding–fourth Canadian bank CEO to retire in the last year. RBC, TD, BNS, and now CIBC. And these guys are not that old. Late fifties, maybe. So it is clear what is going on here–they are cashing out on the highs. It is perfectly rational behavior. Come on–if you were a bank CEO, and you thought that your industry had years of upside left, would you get out? If you were 57? You would not. Let me say it again, more succinctly. 4 out of the 5 Canadian bank CEOs have retired in the last year. That is a complete sentence.

(JaredDilian/DailyDirtnap)

 

 

 

Lots of luck?

 

Bubble needs leverage and a catalyst to burst.

 

Do you see leverage and what could be the catalyst?

 

There's tons of leverage. Look at the all-time high household debt levels. Look at HELOC growth. Look at the size of RE in the canadian economy, look at home ownership levels vs historical, look at where incomes and rents are VS house prices. Ask yourself why houses cost almost twice as much in Canada as in the US, especially with the tepid canadian economy. Look at who the marginal buyers are. Look at how little people have invested elsewhere than in their houses (lots of almost empty RSPs and TFSAs, baby boomers selling to fund their retirements). Look into the moves that the government has been making in the past few years trying to cool things down (you used to be able to buy with 0% down and 40 years amortization a few years ago, and with the popular cash-back mortgages with first time buyers, some people start with negative equity).

 

Catalyst can be almost anything (recession, interest rates rising, commodity cycle, China troubles, US troubles, etc) that leads to a change of sentiment. As long as people believe house prices never go down, they'll keep piling debt and think "better buy now, it'll just be more expensive later". the fact that Canada did relatively well in 2008 only made things worse, because people went "see, it can't happen here, we're immune". But the market already has started softening in parts of the country, and at some point sentiment will turn, and when that happens it can move quickly.

 

I'm not shorting banks or whatever so I have no opinion on timing, but I'm happy to rent until things become more rational (when the toronto RE market crashed in the late 80s, it took something like 14 years to get back to its peak... but this time it's not just toronto, it's almost everywhere).

 

This gives an overview of what's going on, except that things have gotten a bit worse since this was written:

 

http://www.greaterfool.ca/2012/01/08/in-the-end/

[gary17]

I guess we will know...  and hopefully by then my hairs a little greyer and am a little wiser!

 

From the limited things I see in Vancouver, the high end markets in West and North Van - $400M+ houses sold for cash with no subject ....    While those are irrational behaviours - I do wonder if the ... hits the fans... do these folks , do these top 0.1% people really need to sell?  If Vancouver is so desirable and thse are probably 50M+ ultra high net worth individuals - do they need to sell?

 

I'd agree, however, that for the condo market , where the ordinary working class people like myself live .... well... we could take a more serious hit.  And perhaps the 99.9% do make up the bulk of the economy in Canada...  what will we do with the interest rate already at 1%?

 

---

 

Anyway - back to Bank of America -- it's my backup plan.. hopefully when Canada is cheap , BAC will be selling at a premium and I get to upgrade from a condo to a entry level home :)

 

 

 

 

 

[wisdom]

The cash purchases in North Vancouver are financed by HELOC's set up on other real estate. Equity take outs on other properties fund these purchases by speculators. Look at the debt levels in BC - they are the highest in Canada at a time when an average Canadian has $1.63 debt per $1 of income. In the '90s this figure used to be $0.90 for $1 of income

for Canada.

 

An average person in BC now has $38k of unsecured debt.

 

There is an immense amount of fraud in the system and this is why the regulators have been tightening rules over the last 4-5 years.

 

Eg: Banks do not report mortgages on credit bureaus. Thus, person goes to bank A and takes out a mortgage on property 1.

Goes to bank B and says this is my down payment for property 2 and I have no other debt. He is approved for a mortgage on this basis. A large part of the banking industry is responsible for educating the buyers on how to cheat the system in order to earn larger bonuses.

 

Thus, revenue properties are under reported.

 

Another example: a couple is allowed only 1 principal residence for tax purposes. There are couples where each spouse claims to have a separate principal residence.

 

3rd option: Buy each property under a separate holdco. A mortgage in a holdco is not reported on the credit bureau. Even though the mortgage is guaranteed by the owner, he/she does not report it, and buys a new property under a new holdco. There are many people without the capital or income to support the mortgages that they have but end up owning 4-20+ properties.

 

4th option:Have friends buy a property and you act as guarantor. Again the debt does not get reported on the guarantors credit bureau.

 

This is what a bubble looks like from the ground up at it's peak. The leverage is unbelievable in the system. An average house in Vancouver is around $650k with median household income of $68,000. Rental yields are sub 3%. The market has gone up for 12 years. People agree that none of this makes sense but are forced to buy otherwise they will never be able to buy another property. BC has negative net migration because the youth can earn higher incomes in Alberta with lower taxes and much cheaper houses to boot. Everyone who could afford to buy a property has.

 

This cannot end well.

[tombgrt]

 

...

 

This is what a bubble looks like from the ground up at it's peak. The leverage is unbelievable in the system. An average house in Vancouver is around $650k with median household income of $68,000. Rental yields are sub 3%. The market has gone up for 12 years. People agree that none of this makes sense but are forced to buy otherwise they will never be able to buy another property. BC has negative net migration because the youth can earn higher incomes in Alberta with lower taxes and much cheaper houses to boot. Everyone who could afford to buy a property has.

 

This cannot end well.

 

Very informative post, thanks. I assume that median household income is pre-tax? That is insane.

 

Here in Ghent you pay 300-325k € (after taxes and costs) for a property that returns 9-10k € rent / year. That's for maybe 90-100m² in the city centres with 1-2 bedrooms, nothing outlandish. Most other big cities, where most people live, are equally expensive. So that's a rental yield of 3% (before costs!) for real estate at an ok location in the city and it's not all that cheaper the further away you go. Young couples make 30-45k € or maybe 20-40% more if they both went to college and have decent jobs. (Most are unlikely to make a lot more given that we are taxed at 50% (plus some extra's) at a certain point. There are few possibilities to make 10k+ monthly and if you do, you barely keep half.)

We do have some silly tax advantages but I can't see how prices can continue to go up from here, it is simply getting unpayable for most.

 

[Uccmal]

Fair enough guys.  I am not pursuing it here as this is the BAC thread. 

[tombgrt]

You're right, sorry for the off-topic. I assume we have a RE overvaluation topic somewhere where we could continue.

[ERICOPOLY]

"So that's a rental yield of 3% (before costs!) for real estate at an ok location in the city and it's not all that cheaper the further away you go."

 

Similar rental yield to what I'm still paying here in Montecito.

 

However our tax rate in California is so high that I would need to invest the home's price into a bond yielding at least 4.6%-6% in order to get that 3% after-tax.

 

Then the income from the bond would need to rise with rental inflation, but such a bond does not exist! 

 

So to hedge against potentially high rental inflation, I must instead purchase the home.  First, because you can't find equivalently low risk bonds that yield 4.6%-6%, and second because they certainly don't adjust their payouts in lockstep with rising rent.

 

Anyways, that's why it still might be the rational thing to do -- what's the alternative?  Get run over by rising rent?

 

 

 

 

[ERICOPOLY]

It was April 24th when I first learned that the DOJ was going to put a huge fine on BofA:

 

http://dealbook.nytimes.com/2014/04/24/justice-dept-offers-bank-of-america-a-mortgage-deal/?_php=true&_type=blogs&_r=0

 

They've now settled the cash portion for $9b. 

 

Okay, but since that initial headline we still had a week more of earnings at the end of April, then there was May, June, July, and now another week in August.

 

During that period, the company's business performance has increased their available capital (through retained earnings) by approximately $7b.  Now if we wait a month it will be up to around $9b.

 

It's pretty cool how quickly the bank can recover from a penalty like this.

 

 

[gary17]

 

Morning Eric

This is why I like BAC so much. The earnings power is great. I don't know the inside out like you, xazp and others do... but I like 14%ROE and 0.8book... plus slow growth, this beats a  higher growth company trading at a premium to book.

 

 

 

It was April 24th when I first learned that the DOJ was going to put a huge fine on BofA:

 

http://dealbook.nytimes.com/2014/04/24/justice-dept-offers-bank-of-america-a-mortgage-deal/?_php=true&_type=blogs&_r=0

 

They've now settled the cash portion for $9b. 

 

Okay, but since that initial headline we still had a week more of earnings at the end of April, then there was May, June, July, and now another week in August.

 

During that period, the company's business performance has increased their available capital (through retained earnings) by approximately $7b.  Now if we wait a month it will be up to around $9b.

 

It's pretty cool how quickly the bank can recover from a penalty like this.

[xazp]

Eric,

 

  I'm not positive but you may be over-estimating BAC's capital generation due to the Buffett conversion in Q2? 

 

  Let's discuss capital a little more. 

 

  Here's where I'm at right now.  Between the last CCAR submission (Q3/2013) and now, they've generated about $5Bn in capital.  This is pretty good considering they've had about $10Bn in pre-tax settlements, plus a $4Bn disappearance in capital ratios. 

  In Q3, I figure they'll add $2.5Bn more capital, ($3.5Bn from earnings, $1.5 billion in DTA minus $2.5Bn for the completion of the settlement). 

  So I figure when they submit CCAR this fall, they'll be ahead by about $7.5Bn year/year.

 

  The last CCAR (before $4Bn of capital disappeared) allowed them to return $4Bn in stock repurchases + about $2.2Bn in dividends.  So about a $6.2Bn capital return. 

 

    So if CCAR is a constant difficulty, it suggests BAC could return $6.2Bn (last year's approved request) + $7.5Bn (capital generation over last year)  = $14B in capital returns.

Probably won't happen, but is $10Bn out of the question? 

 

    Then, assuming no more multi-billion dollar mix-ups, BAC should be able to earn and return $20Bn of capital per year from 2015 onward. 

 

    My grand hope (which seems to get dashed regularly) - $24Bn in earnings, 8Bn shares (they come down quickly if they can really return $20Bn/year in capital) in a couple years = $3/share.  Unrealistic? 

 

 

 

 

 

 

 

 

 

 

 

It was April 24th when I first learned that the DOJ was going to put a huge fine on BofA:

 

http://dealbook.nytimes.com/2014/04/24/justice-dept-offers-bank-of-america-a-mortgage-deal/?_php=true&_type=blogs&_r=0

 

They've now settled the cash portion for $9b. 

 

Okay, but since that initial headline we still had a week more of earnings at the end of April, then there was May, June, July, and now another week in August.

 

During that period, the company's business performance has increased their available capital (through retained earnings) by approximately $7b.  Now if we wait a month it will be up to around $9b.

 

It's pretty cool how quickly the bank can recover from a penalty like this.

[ERICOPOLY]

Eric,

  I'm not positive but you may be over-estimating BAC's capital generation due to the Buffett conversion in Q2? 

 

I'm just crediting them with a pace of roughly $500m per week from pre-tax after-provision earnings.

 

Nothing more complicated than that. Ignores other settlement costs, ignores the Buffett conversion, ignores capital freed up from runoff of real estate loans, etc...

 

Nine billion dollars sounds like a lot of money, so I wanted to put it into a time-context.

 

Nine billion dollar cash penalty to BAC is the same as not making any money for 4.5 months.  Penalty is not that bad.  I'm assuming they've already written down most of the other parts of the penalty concerning loan-forgiveness.

 

[xazp]

OK I like your method.  I think what you're doing is, based on Q2:

 

$3.4Bn (reported) pre-tax, pre-provision earnings

+$4Bn pre-tax litigation charge

-$.4Bn in provisions

= 7Bn pre-tax, pre-provision

then dividing that by 13, 14 weeks in a qiarter?  [though I'd warn, the provision number is not sustainable at that low level]. 

 

OK using your number, and assuming a $2.5Bn pre-tax litigation charge, I think BAC can ask for around $16Bn in capital returns when CCAR rolls around.  I doubt they will ask for that much but 2015 could still be pretty impressive if they ask for $10Bn+. 

 

Maybe you can roll your own CCAR numbers and see what you come up with. 

 

 

Eric,

  I'm not positive but you may be over-estimating BAC's capital generation due to the Buffett conversion in Q2? 

 

I'm just crediting them with a pace of roughly $500m per week from pre-tax after-provision earnings.

 

Nothing more complicated than that. Ignores other settlement costs, ignores the Buffett conversion, ignores capital freed up from runoff of real estate loans, etc...

 

Nine billion dollars sounds like a lot of money, so I wanted to put it into a time-context.

 

Nine billion dollar cash penalty to BAC is the same as not making any money for 4.5 months.  Penalty is not that bad.  I'm assuming they've already written down most of the other parts of the penalty concerning loan-forgiveness.

[ERICOPOLY]

[though I'd warn, the provision number is not sustainable at that low level]. 

 

Nor is $0 normal for litigation expenses.

 

But I figure neither is $1.3b quarterly LAS expenses. 

 

Strip out some of the LAS and sprinkle it into normal provisioning and normal litigation.

 

 

[xazp]

Yep.  I think BAC is at about $1.50/share when you normalize everything out on today's numbers. 

 

Interest rates should boost earnings to around $2/share.  And I have hopes they can close the gap with their higher-earning peers like JPM and WFC to get above that and also trim the share count with buybacks. 

 

Something that has crossed my mind:  BAC is running off a bunch of bad loans (still).  Those HELOCs are going to take many years to burn through.  Is it possible that as BAC transitions to more conservative lending, that provisions remain low for years to come?  That is the flip side of (for example) stagnant revenue and assets- it's because they have loan portfolios in run-off that aren't being replaced.  But the upside (maybe?) is that provisions can keep dropping as they replace poorly-underwritten loans with good ones. 

 

Do you think LAS can drop below $500MM/quarter?  I know we have not broached that topic, but, they indicated that 60-day delinquents of 300K means $500MM/quarter, but they're below that level of delinquents and it keeps dropping.

 

 

 

 

 

 

 

[though I'd warn, the provision number is not sustainable at that low level]. 

 

Nor is $0 normal for litigation expenses.

 

But I figure neither is $1.3b quarterly LAS expenses. 

 

Strip out some of the LAS and sprinkle it into normal provisioning and normal litigation.

[Mephistopheles]

Xazp, why do you think the provision level is not sustainable, and how would you arrive at the correct provision level?

[ERICOPOLY]

Some of your questions are getting well out of my league...

 

But I don't disagree, the present numbers point to around $1.50.  Or perhaps a bit under $1.60.

 

Anyways, $1.50 is only 10.7% return on tangible equity.  The bank executives commented that they can do 13%-14% return on tangible equity... in this interest rate environment.

 

Of course, people have pretty much written off anything they say at this point given their seemingly complete ignorance around the costs of settling their legal issues.  Okay, so forecasting the DOJ is out of their league, but they are bankers and knowing if they can get at least 13% ROTE is something I think they are more qualified to comment on.

 

So while they aren't currently earnings 13%, they seem to have an idea that it can be done by shifting things around.  Could they lie that badly?  Surely they aren't so incompetent that they can't look at their Q2 numbers the way we did and see that 10.7% is nowhere close to 13%.  So I "have faith", but I'm protected by the stock price if faith is misguided.

 

 

 

Yep.  I think BAC is at about $1.50/share when you normalize everything out on today's numbers. 

 

Interest rates should boost earnings to around $2/share.  And I have hopes they can close the gap with their higher-earning peers like JPM and WFC to get above that and also trim the share count with buybacks. 

 

Something that has crossed my mind:  BAC is running off a bunch of bad loans (still).  Those HELOCs are going to take many years to burn through.  Is it possible that as BAC transitions to more conservative lending, that provisions remain low for years to come?  That is the flip side of (for example) stagnant revenue and assets- it's because they have loan portfolios in run-off that aren't being replaced.  But the upside (maybe?) is that provisions can keep dropping as they replace poorly-underwritten loans with good ones. 

 

Do you think LAS can drop below $500MM/quarter?  I know we have not broached that topic, but, they indicated that 60-day delinquents of 300K means $500MM/quarter, but they're below that level of delinquents and it keeps dropping.

 

 

 

 

 

 

 

[though I'd warn, the provision number is not sustainable at that low level]. 

 

Nor is $0 normal for litigation expenses.

 

But I figure neither is $1.3b quarterly LAS expenses. 

 

Strip out some of the LAS and sprinkle it into normal provisioning and normal litigation.

[xazp]

I think they commented 14% ROTE / 1% ROA assuming a 100bps parallel rise.  So I'm somewhat calibrating with his comments here ($2/share after an interest rate rise). 

 

Last quarterly call (Q&A with Mayo)

" that as we look out to and as we look at and embed in our models of 100 basis point parallel shift in the yield curve that we are looking at that point with a tangible common equity ratio of 7% and return on asset of 1% to be at a 14% return on tangible common equity."

 

I don't think they are lying, but, if you look at the 2011 investor presentation, they have not come anywhere close to their promises to shareholders.  They were talking $45Bn in PPNR, and $2/share in capital returns.  So yeah, management credibility is not great and ... what has moyinhan really done for shareholders since coming on board?  I don't know why everyone likes him. 

 

 

 

 

 

Some of your questions are getting well out of my league...

 

But I don't disagree, the present numbers point to around $1.50.  Or perhaps a bit under $1.60.

 

Anyways, $1.50 is only 10.7% return on tangible equity.  The bank executives commented that they can do 13%-14% return on tangible equity... in this interest rate environment.

 

Of course, people have pretty much written off anything they say at this point given their seemingly complete ignorance around the costs of settling their legal issues.  Okay, so forecasting the DOJ is out of their league, but they are bankers and knowing if they can get at least 13% ROTE is something I think they are more qualified to comment on.

 

So while they aren't currently earnings 13%, they seem to have an idea that it can be done by shifting things around.  Could they lie that badly?  Surely they aren't so incompetent that they can't look at their Q2 numbers the way we did and see that 10.7% is nowhere close to 13%.  So I "have faith", but I'm protected by the stock price if faith is misguided.

 

 

 

Yep.  I think BAC is at about $1.50/share when you normalize everything out on today's numbers. 

 

Interest rates should boost earnings to around $2/share.  And I have hopes they can close the gap with their higher-earning peers like JPM and WFC to get above that and also trim the share count with buybacks. 

 

Something that has crossed my mind:  BAC is running off a bunch of bad loans (still).  Those HELOCs are going to take many years to burn through.  Is it possible that as BAC transitions to more conservative lending, that provisions remain low for years to come?  That is the flip side of (for example) stagnant revenue and assets- it's because they have loan portfolios in run-off that aren't being replaced.  But the upside (maybe?) is that provisions can keep dropping as they replace poorly-underwritten loans with good ones. 

 

Do you think LAS can drop below $500MM/quarter?  I know we have not broached that topic, but, they indicated that 60-day delinquents of 300K means $500MM/quarter, but they're below that level of delinquents and it keeps dropping.

 

 

 

 

 

 

 

[though I'd warn, the provision number is not sustainable at that low level]. 

 

Nor is $0 normal for litigation expenses.

 

But I figure neither is $1.3b quarterly LAS expenses. 

 

Strip out some of the LAS and sprinkle it into normal provisioning and normal litigation.

[xazp]

Their reserves for loan losses are down by about $5.4Bn y/y.  They can't keep dropping reserves forever, the number can't go anywhere near zero, or negative.  So there's some limit to how much of this they can do. 

 

Xazp, why do you think the provision level is not sustainable, and how would you arrive at the correct provision level?

[gary17]

I think many of us here agree the intrinsic value is higher.... so what would be the catalyst? I think without one it could sit at the 15$ level for a while.

 

I suppose when the earnings start to come in at higher levels as one...

[ERICOPOLY]

I think they commented 14% ROTE / 1% ROA assuming a 100bps parallel rise.  So I'm somewhat calibrating with his comments here ($2/share after an interest rate rise). 

 

He said 13% to 14% last Nov-Dec during the Q&A (recorded audio was once on the website) at an investor conference.  He specifically said it was for the "present" interest rate environment, I posted it here (it's buried somewhere in this thread), and then Sanjeev posted that he agreed with me that Moynihan did indeed say it.

 

Of course, the most recent comment is a better one because there is always a chance that he's simply changed his mind.

 

The difference between 10.7% ROTE and 14% ROTE is 3.3% (330 bps of ROTE)

 

Just eyeballing it, that feels like way too large of a move to be coming from a 100 bps parallel rise.

[Mephistopheles]

Their reserves for loan losses are down by about $5.4Bn y/y.  They can't keep dropping reserves forever, the number can't go anywhere near zero, or negative.  So there's some limit to how much of this they can do. 

 

Xazp, why do you think the provision level is not sustainable, and how would you arrive at the correct provision level?

 

Gotcha, so how would you suggest calculating the normal level of provisions or the reserves?

[ERICOPOLY]

Instead, look at the returns on allocated capital in each of their business segments.

 

Then go back and look at the 10.7% ROTE number.  How can it really be this bad given the returns they generate on allocated capital in each segment?  I fully understand that the entire entity cannot be as leveraged and such so I can't expect ROTE to be anywhere near the returns they make on allocated capital... but neither can JPM escape that problem. 

 

I want to compare their returns on allocated capital for the various businesses against what JPM achieves in their businesses.  Something doesn't add up, because I believe JPM is getting something like 14% ROTE already.