BAC-WT - Bank of America Warrants

[giofranchi]

For example, anyone here who owns/has owned a business...does your BV really matter on a regular basis?

 

To me the only thing that matters in business is the "money in my pocket". And the only reason I own my businesses is because I think they are good machines to increase that "money in my pocket" at a satisfactory rate.

Of course the "money in my pocket" is only figurative. And there are essentially three ways my businesses generate cash that goes to increase what I figuratively call the "money in my pocket":

1) Through a salary (I am CEO and I get paid)

2) Through increasing their capital or equity (I am an owner and I own a percentage of that capital)

3) Through dividends (just add buy backs in the case of a public company)

If I don’t receive a salary, and the company doesn’t pay a dividend (nor buys back shares), I want to see its equity grow… Otherwise, where is the money going?? Certainly not in my pocket!! ;)

 

Gio

 

[Guest Dazel]

 

Gio,

 

The answer of course is both.

B of A's book value is not a plant in northern Italy....it's a liquid cash producing asset...Merrill Lynch is worth every cent of it's good will and then some...the acquisition saved the company. Please look at historical multiples on book values in a well performing global brand bank...there is reason they "normally" trade at high multiples to book...my guess is 2 to 1..likely higher over the last 30 years.

Why?

 

1. It's a leveraged asset....that is the business...that is why deposits are everything...Buffett gave you that clue for those that listened.

 

2. Earnings are "cash"...plus depreciation and non cash write off's....cashflow is king always. There is "no" cashflow like a financial company that is killing it....that is "not" happening right now...so roe's and roa's are not normal.

 

3. Read up on the Davis family if you would like to learn more on financials in particular...the negative brush of 2008 has allowed us the opportunity now..not unlike the 70's when first generation of the Davis family made a killing buying them cheap.

 

4. My BH holdings study is limited to none...but I when I sleep I know that B of A is making interest, and doing business globally in investment banking etc.....that is a type of brand cashflow that is similar to royalties that I love. BH holdings has to be very good at physical distribution of food, weather, customers prices...and 200 other things done right to be successful...if you can do these as an entrepreneur than the results can be very very good. These returns are many fold what B of A will do over many years...if you find a great entrepreneur at the right time you can become rich. Prem Watsa has done that for us....but you have to find the right time to buy in.

 

If you bought FFH in 1998...and did not average down... You are still disappointed. If you bought in when we did you have a picture of Prem and his team in the office! We did not really buy in on book value even though it was well below it with a lot of doubt over their good will!!!!! The bond gains I knew they had would effect both book value and cash flow.

 

B of A is a lot easier to figure  out (it wasn't with the litigation over hang) because of the brands reoccurring income but it does not have the multiple bagger opportunity that FFH, Prem and other great entrepreneurs have. It will be worth $25 to $30 when they start to show their earnings power.

 

 

Dazel

 

[Guest Dazel]

http://brandirectory.com/league_tables/table/global-500-2014

 

 

I bet the majority here on this board will be surprised by Bank of America's brand recognition....in light of the last 6 years....

 

 

[giofranchi]

Thank you very much Dazel,

 

Please look at historical multiples on book values in a well performing global brand bank...there is reason they "normally" trade at high multiples to book...my guess is 2 to 1..likely higher over the last 30 years.

 

Well, maybe… it just seems a bit strange to me that in a business, like the banking business, in which the amount of business you can do is somewhat regulated and closely tied to the capital you have, basically it is a multiple of that capital, equity and its growth are not useful to value the business… After all, banks are not biotech companies, where all the capital you need is of the intellectual kind… Am I wrong?

 

BH holdings has to be very good at physical distribution of food, weather, customers prices...and 200 other things done right to be successful...

 

I think the fast-food franchising business is almost the same thing as the royalty business. I don’t see any difference. It is not BH that will do all those things you have listed. BH will only receive a percentage of the revenues from the people who will do all those things you have listed.

 

Gio

[giofranchi]

http://brandirectory.com/league_tables/table/global-500-2014

 

 

I bet the majority here on this board will be surprised by Bank of America's brand recognition....in light of the last 6 years....

 

Yeah! Very strong and valuable brand!

 

But look just two places below: we find McDonald's, which is in the fast-food franchising business ;)

 

Gio

[Uccmal]

 

Gio,

 

The answer of course is both.

B of A's book value is not a plant in northern Italy....it's a liquid cash producing asset...Merrill Lynch is worth every cent of it's good will and then some...the acquisition saved the company. Please look at historical multiples on book values in a well performing global brand bank...there is reason they "normally" trade at high multiples to book...my guess is 2 to 1..likely higher over the last 30 years.

Why?

 

1. It's a leveraged asset....that is the business...that is why deposits are everything...Buffett gave you that clue for those that listened.

 

2. Earnings are "cash"...plus depreciation and non cash write off's....cashflow is king always. There is "no" cashflow like a financial company that is killing it....that is "not" happening right now...so roe's and roa's are not normal.

 

3. Read up on the Davis family if you would like to learn more on financials in particular...the negative brush of 2008 has allowed us the opportunity now..not unlike the 70's when first generation of the Davis family made a killing buying them cheap.

 

4. My BH holdings study is limited to none...but I when I sleep I know that B of A is making interest, and doing business globally in investment banking etc.....that is a type of brand cashflow that is similar to royalties that I love. BH holdings has to be very good at physical distribution of food, weather, customers prices...and 200 other things done right to be successful...if you can do these as an entrepreneur than the results can be very very good. These returns are many fold what B of A will do over many years...if you find a great entrepreneur at the right time you can become rich. Prem Watsa has done that for us....but you have to find the right time to buy in.

 

If you bought FFH in 1998...and did not average down... You are still disappointed. If you bought in when we did you have a picture of Prem and his team in the office! We did not really buy in on book value even though it was well below it with a lot of doubt over their good will!!!!! The bond gains I knew they had would effect both book value and cash flow.

 

B of A is a lot easier to figure  out (it wasn't with the litigation over hang) because of the brands reoccurring income but it does not have the multiple bagger opportunity that FFH, Prem and other great entrepreneurs have. It will be worth $25 to $30 when they start to show their earnings power.

 

 

Dazel

 

Great posts Dazel.  You articulate very well what I see in a bank, and BAc especially, and JPM, and WFC (all of which I hold).  All of them are cash flow machines.  At its base each is an extremely simple business model. 

 

 

[SharperDingaan]

Compare the BAC brand to a Louis Vuitton (LVMH) ... which we own.

 

Both firms owe the bulk of their business to their brands; LVMH does not just make clothes & spirits, many others do as well... but add in the intangibles & you get to just a handful of firms in the very lux & global market. BAC is one of only 3-4 banks in the US; in the Spanish speaking world ... even fewer.

 

In the banking world, regulatory capital is the broad equivalent to book value in manufacturing; The better the machinery the more business the manufacturer can do, & BV largely represents the financial state of that manufacturing machinery after cumulative usage & obsolescence. In banking it is not just how much regulatory capital you have, but the quality of it as well (Basel Tier 1, 2, etc.)

 

The 3 part model, requires an additional part (regulatory capital), for application to banking. The immediate impacts of stock issuance & RE, increase equity - & are easy to see; the immediate effect of replacing debs with COCO & bail-in bonds, or moving to high quality vs low quality business - not so much. The LV handbag made in Paris, vs Shanghai, looks the same - but most would argue the Paris copy is higher quality; unlike banking - the LVMH is able to charge for that perception - immediately.

 

Until Lehman, global banks were being allowed to collapse; Lehman proved there was so much toxic waste in the system - that to use the strategy would be to collapse the global industry, & usher in the Great Recession II. Over the years; the waste has been diluted by roll-overs, charge-offs against manufactured gains (sovereign funding at .25% relent at .75%), fine paying (Barclays), & wholesale equity raises. It is testament to just how corrupt the industry is/was, that there is still a ways to go; below par ROE will be with us for quite some time yet.

 

It is also useful to keep in mind the old comic where following a ships sinking, both Toff & soot covered boiler navvy are observed floating (alive) on the surface. The caption reads - Funny how the scum always floats to the top!

 

Not all scum looks the same.

 

SD

 

 

 

[Guest Dazel]

 

Gio,

 

I very much like the franchise food business however, at times food inflation...diet fads, oil prices-transportation, supply chain problems (food scares) do happen...like I said I do not know BH holdings.

 

I have made a lot of money in the industry...my flaw is selling too early...we were large buyers  of Tim Horton's and Starbucks in 2009.  Food deflation and great brands were a slam dunk....it's was"huge" mistake to have sold them...likely my biggest mistake. Starbucks went up over 7 times in that period...and we knew the brand as good as anyone. I am hopin to have that same problem here but the reality is BAC is too big to do that. I see it as more of a utility without capex (all the cash will get paid to us) in the $25 to $30 range with big dividend hikes going forward.

 

Good luck all!

 

Dazel.

 

[ni-co]

Wells chief warns on mortgage lending

John Stumpf said government-backed agencies that buy mortgages, such as Fannie Mae, Freddie Mac and the Federal Housing Administration, were too quick to accuse banks of faulty underwriting on mortgages that default and force them to repurchase the soured loans, known as “put-back” risk.

 

“If you guys want to stick with this programme of ‘putting back’ any time, any way, whatever, that’s fine, we’re just not going to make those loans and there’s going to be a whole bunch of Americans that are underserved in the mortgage market,” Mr Stumpf told the Financial Times.

…

Alongside record penalties for banks that acknowledged wrongdoing, which continue today, officials have demanded more rigorous underwriting and tightened lending criteria. But there is a growing body of opinion, among some officials not just bankers, that credit in the market has become too tight.

 

http://www.ft.com/intl/cms/s/0/cdfe20f8-2a2d-11e4-a068-00144feabdc0.html (paywall)

 

You can't have it both ways…

[LesPaul]

Slightly off-topic - but I follow the mortgage industry in Canada fairly closely and I see this from the consumer side too.

 

"Entitlement" might not be the right word, but consumers don't feel too great about your company when they're not deemed worthy of financing. Alternatively, people also get upset when they aren't getting the same "great rate" their friends are (perhaps due to credit history, job situation etc.) and they forget that someone is taking a risk on the other side (the Canadian taxpayer via government run default insurance).

 

 

 

 

[rohitc99]

http://fortune.com/2014/08/27/moynihan/

 

the most underrated CEO in america

[ni-co]

http://fortune.com/2014/08/27/moynihan/

 

the most underrated CEO in america

 

Thanks, this article is really a great piece of financial journalism.

[craigatk]

http://fortune.com/2014/08/27/moynihan/

 

the most underrated CEO in america

 

...hung like the sword of Damocles over the bank.

 

Love this quote. Great article and thanks for sharing. Continue to be very pleased to own some tarp warrants.

[xazp]

I hesitate to endorse Fortune, but, their thinking is pretty much in line with mine so I have to.  Thanks for pointing out the article.  Is he on the cover?  Because cover articles are often contrary indicators. 

 

 

http://fortune.com/2014/08/27/moynihan/

 

the most underrated CEO in america

[OracleofCarolina]

Pope Francis is on the most recent cover but I did not see this story in there.

[ap1234]

I enjoyed the article. As many people on the board have said for years, Moynihan is one of the most underappreciated CEOs in America.

 

I had a quick question on the math in the article.

 

-Revenues: $90 billion (assumes no change in int. rates)

-Operating expenses: $57 billion (includes $4 billion in extraordinary servicing costs)

-Pre-tax income: $33 billion

-Net income: $21.5 billion (assumes 35% in taxes, ignores the value of the DTAs)

 

Where do provisions for credit losses play into this? Did the author lump credit losses into the operating expense line item? If not, what is a reasonable level of 'normalized' credit losses on a go forward basis?

 

Disclosure: Long BAC.

[ERICOPOLY]

http://fortune.com/2014/08/27/moynihan/

 

the most underrated CEO in america

 

Seems like he made an error here:

 

Keep in mind that BofA also pays $1.1 billion a year in dividends on preferred stock owned by Berkshire Hathaway.

 

 

[CorpRaider]

I like Corbat better, but I'm probably biased as a native english speaker.

[xazp]

They're missing $4-$5Bn in credit losses in their analysis.  This is why BAC's last conference call says the 1% ROA target needs 100bps parallel rise.  Based on their guidance, the 100bps rise in interest rates is ~equal to current under-estimates of credit losses, so you'd end up with ~$22Bn after the rise, rather than before as she conjectures. 

 

I enjoyed the article. As many people on the board have said for years, Moynihan is one of the most underappreciated CEOs in America.

 

I had a quick question on the math in the article.

 

-Revenues: $90 billion (assumes no change in int. rates)

-Operating expenses: $57 billion (includes $4 billion in extraordinary servicing costs)

-Pre-tax income: $33 billion

-Net income: $21.5 billion (assumes 35% in taxes, ignores the value of the DTAs)

 

Where do provisions for credit losses play into this? Did the author lump credit losses into the operating expense line item? If not, what is a reasonable level of 'normalized' credit losses on a go forward basis?

 

Disclosure: Long BAC.

[wachtwoord]

Everyone here seems to be very enthusiastic about BAC. Personally I find it very hard to value banks (partly because I think the entire system is one big scam, but alas) so I checked what Morningstar has to say:

 

We are raising our base-case valuation to $16 per share from $15, based on a combination of the time value of money since our last update and management's continued progress on the expense front. This equates to approximately 1.1 times reported tangible book value per share as of June 30 and 11 times our 2015 earnings per share estimate. We do not expect much asset growth in the near term. We believe the bank will make significant progress on its expense-control initiatives, balanced by slow increases in net interest margin, resulting in a 64% efficiency ratio by the end of our five-year forecast period. We expect the net interest margin to average 2.7% in the long run, as rates remain under pressure over time. In the long run, we forecast net charge-offs averaging 0.7% of loans. We expect Bank of America to maintain a tangible common equity ratio of around 7.5% according to our calculation, as it currently meets anticipated Basel III requirements. We use a 10% cost of equity, reflecting the bank's increased capital levels and moderate exposure to trading income.

 

with a narrow moat and high uncertainty.

 

Can anyone comment on that?

[ap1234]

Thanks xazp. I had only taken a quick glance at the article before. On further inspection, there seem to be a few inaccuracies with the numbers. Eric pointed out that the Buffett dividend is overstated.

 

What about the interest cost on the debt? Is that captured in the pro-forma NI?

[ERICOPOLY]

Everyone here seems to be very enthusiastic about BAC. Personally I find it very hard to value banks (partly because I think the entire system is one big scam, but alas) so I checked what Morningstar has to say:

 

We are raising our base-case valuation to $16 per share from $15, based on a combination of the time value of money since our last update and management's continued progress on the expense front. This equates to approximately 1.1 times reported tangible book value per share as of June 30 and 11 times our 2015 earnings per share estimate. We do not expect much asset growth in the near term. We believe the bank will make significant progress on its expense-control initiatives, balanced by slow increases in net interest margin, resulting in a 64% efficiency ratio by the end of our five-year forecast period. We expect the net interest margin to average 2.7% in the long run, as rates remain under pressure over time. In the long run, we forecast net charge-offs averaging 0.7% of loans. We expect Bank of America to maintain a tangible common equity ratio of around 7.5% according to our calculation, as it currently meets anticipated Basel III requirements. We use a 10% cost of equity, reflecting the bank's increased capital levels and moderate exposure to trading income.

 

with a narrow moat and high uncertainty.

 

Can anyone comment on that?

 

My comment is that they are focused on the multiple to 2015 earnings, and the current multiple to tangible book, neither of which is terribly relevant to the long term value of the company.  One year of earnings, really guys?  Don't forget you charge money for this stuff.

 

This equates to approximately 1.1 times reported tangible book value per share as of June 30 and 11 times our 2015 earnings per share estimate.

 

[xazp]

I think it has a pretty wide moat and I'll give you three examples. 

 

First, Buffett's promised to hold his warrants to maturity, which means he intends to hold it for at least 10-years.  Wells and Amex are multi-decade positions.  That suggests he believes their value will be higher in a decade, or several decades, than today.  To me that implies they have a moat.  He doesn't see them getting clobbered by some competitor over a period of at least a decade. 

 

Second, think about all the negative publicity that BAC has.  They're constantly in the headlines for screwing something up, getting sued.  Occupy Wall Street suggested you close out bank accounts.  Their brand has been dragged through the mud over the past few years.  Yet, somehow, they pay less on deposits than almost anyone, and their deposit base keeps growing.  How can a narrow moat company simultaneously pay the least, and keep growing their deposit base?  How is it that something like Ally bank can pay multiples of BAC's deposit rates, and BAC can pile on deposits faster? 

 

Third, I'd actually argue there is a strong regulatory moat around the big banks.  The capital rules were designed to apply pressure to big banks to shrink.  But the inverse of this, it's almost impossible for a non-large bank to become a large bank.  So, you have a permanent oligopoly of large banks where new entrants are not possible.  So for services where a large customer needs (for example) treasury services, commodity purchasing, and commercial lending - there's only a few companies that can provide these services, and the number is not getting any larger.

 

 

 

 

 

with a narrow moat and high uncertainty.

 

Can anyone comment on that?

[ni-co]

Thanks xazp. I had only taken a quick glance at the article before. On further inspection, there seem to be a few inaccuracies with the numbers. Eric pointed out that the Buffett dividend is overstated.

 

What about the interest cost on the debt? Is that captured in the pro-forma NI?

 

The numbers in this article are more of the back of the envelope kind. However, I very much like the kind of thinking he did and I stick with my praise for it. If only the other 99% of articles in financial journals out there had this kind of flaws, it would be great. The author should have read this thread before writing it, though. ;)

 

with a narrow moat and high uncertainty.

 

Yeah, the only thing you need to steal their business is a low-cost 1 trillion deposit base.

[xazp]

It's not really "back of the envelope" for a bank if they are not modeling credit losses ...

 

The trillion dollars of low cost deposits is very, very difficult, but not impossible.  What makes it impossible is your bank would be instantly shut down for being severely under-capitalized (and the Fed would insist that your deposits be transferred to BAC or JPM or WFC). 

 

To me that's the real crux of the issue.  Capital levels are like the financial equivalent of a factory.  You need capital to issue loans or to buy interest bearing securities.  But, regulators have tight constraints on capital.  You'd need > $100 billion of capital to support your trillion dollar deposit base.  In the past, this might have been possible by merging 5-$20 billion banks, but, large mergers are no longer permitted by regulators.  It would take an excruciatingly long time to get to BAC's size without mergers. 

 

 

Thanks xazp. I had only taken a quick glance at the article before. On further inspection, there seem to be a few inaccuracies with the numbers. Eric pointed out that the Buffett dividend is overstated.

 

What about the interest cost on the debt? Is that captured in the pro-forma NI?

 

The numbers in this article are more of the back of the envelope kind. However, I very much like the kind of thinking he did and I stick with my praise for it. If only the other 99% of articles in financial journals out there had this kind of flaws, it would be great. The author should have read this thread before writing it, though. ;)

 

with a narrow moat and high uncertainty.

 

Yeah, the only thing you need to steal their business is a low-cost 1 trillion deposit base.