BAC-WT - Bank of America Warrants

[CorpRaider]

Narrow moat my ass.  Perhaps they should defer to the investor who coined the term (if not the concept) around which they have constructed their entire analytical framework?

[ni-co]

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

 

All told, the bank has lowered its operating cost base of employees, systems, buildings and the like—excluding litigation and the servicing of delinquent loans—by almost $8 billion a year, to around $53 billion.

…

Right now, revenues are running at $90 billion, without adding any growth from a rise in rates. Operating expenses, as I said up top, are $53 billion. To that number, we’ll add $4 billion in extraordinary servicing costs, though that number will keep shrinking.

 

What are those "$4 billion in extraordinary servicing costs" in his model? I think he means "servicing of delinquent loans" – which would be credit losses, wouldn't they?

 

[ni-co]

Narrow moat my ass.  Perhaps they should defer to the investor who coined the term (if not the concept) around which they have constructed their entire analytical framework?

 

;D

[xazp]

LAS "legacy asset servicing" costs.  These are costs related to foreclosures and the foreclosure agreement.  And the leading indicator of these costs is the number of people delinquent on their loans today. 

 

BAC estimates $500MM/quarter in LAS costs perhaps end of 2015, versus $1.4Bn last quarter.  So that's where the $4Bn is coming from.  It's quite likely they're paying litigation/legal fees above normal now too. 

 

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

 

Right now, revenues are running at $90 billion, without adding any growth from a rise in rates. Operating expenses, as I said up top, are $53 billion. To that number, we’ll add $4 billion in extraordinary servicing costs, though that number will keep shrinking.

 

What are those "$4 billion in extraordinary servicing costs" in his model?

[ni-co]

Ok. Thanks, I see. Yes, then there is really quite a mistake in their model.

 

Another question to all of you, guys: If his assumption of a 6-7% growth rate and 0% reinvestment rate were actually true, what would be a proper p/e multiple in your opinion? 16? Surely not 12. The only thing BAC would have to do at this multiple is buying back stock all day.

 

If Mr Market calms down with regard to financials and BAC makes $2 eps growing 6% per year, where should the stock price be in a normal market environment?

[xazp]

I think it's a tough question, because historically banks have traded at a discount to the market.  I personally assume a P/E of 10, but, at that price they should be able to grow earnings about 10%/year through buybacks and organic growth, so I'd say $20, with the share price growing at 10%/year. 

 

Of course the P/E could be higher or lower than that.  But I personally don't like to assume multiple expansion because then you can justify nearly any price.  Then if they do get multiple expansion, you receive a pleasant surprise. 

 

 

 

Ok. Thanks, I see. Yes, then there is really quite a mistake in their model.

 

Another question to all of you, guys: If his assumption of a 6-7% growth rate and 0% reinvestment rate were actually true, what would be a proper p/e multiple in your opinion? 16? Surely not 12. The only thing BAC would have to do at this multiple is buying back stock all day.

 

If Mr Market calms down with regard to financials and BAC makes $2 eps growing 6% per year, where should the stock price be in a normal market environment?

[ni-co]

A p/e multiple of 10 would severely underprice BAC, if earnings became really that stable. Here is my dreamworld/phantasyland scenario at a p/e of 12:

 

Assumptions:

6% earnings growth;

100% of earnings go into buybacks (to make it easy at the end of the year all at once);

BAC stays at a pe of 12 all the time;

 

2015:

Share count beginning: 11.1bn

Earnings: 22bn

EPS: $1.98

Share price: 23.80

Repurchased shares: 925m

 

2016:

Share count beginning: 10.2bn

Earnings: 23.3bn

EPS: $2.29

Share price: 27.50

Repurchased shares: 848m

 

2017:

Share count beginning: 9.32bn

Earnings: 24.7bn

EPS: $2.65

Share price: 31.80

Repurchased shares: 777m

 

2018:

Share count beginning: 8.54bn

Earnings: 26.2bn

EPS: $3.06

Share price: 31.80

Repurchased shares: 712m

 

2019:

Share count beginning: 7.84bn

Earnings: 27.77bn

EPS: $3.54

Share price: 42.53

[Picasso]

A p/e multiple of 10 would severely underprice BAC, if earnings became really that stable. Here is my dreamworld/phantasyland scenario at a p/e of 12:

 

 

Not sure how a P/E of 10 dramatically undervalues BAC.  If you look out to 2019, I would think there is going to be a cyclical downturn somewhere in there.  In addition to this, even if short-term rates move up from the Fed there is no guarantee long term rates will also move at the same pace.  You could very likely see a nearly flat yield curve in the future (it continues to flatten as we speak).

 

This also ignores the facts that banks inherently use a lot of leverage to achieve those earnings.  The market usually pays a lower multiple for a highly levered business.  You could actually see a future multiple lower than 10x on a bank stock.  If you believe BAC will be repurchasing that much stock, then it might not be a bad thing.  But I wouldn't bank on a higher multiple as part of the thesis.

[ni-co]

A p/e multiple of 10 would severely underprice BAC, if earnings became really that stable. Here is my dreamworld/phantasyland scenario at a p/e of 12:

 

 

Not sure how a P/E of 10 dramatically undervalues BAC.  If you look out to 2019, I would think there is going to be a cyclical downturn somewhere in there.  In addition to this, even if short-term rates move up from the Fed there is no guarantee long term rates will also move at the same pace.  You could very likely see a nearly flat yield curve in the future (it continues to flatten as we speak).

 

This also ignores the facts that banks inherently use a lot of leverage to achieve those earnings.  The market usually pays a lower multiple for a highly levered business.  You could actually see a future multiple lower than 10x on a bank stock.  If you believe BAC will be repurchasing that much stock, then it might not be a bad thing.  But I wouldn't bank on a higher multiple as part of the thesis.

 

As I said, this is phantasyland and very rough. If you assume a 10x multiple you're going to get out at ~$38 per share in 2019.

 

I whipped this up with Soulver. If you have the app and a Mac/iOS device, you can play around with different growth and multiple assumptions.

bac_growth.soulver

[topofeaturellc]

the multiple of earnings is more a function of ROE - both the current and normal ROE - mostly because ROE or marginal ROE is a really good measure of profitability. 

 

If you thought BAC was earning its normal ROE paying 10x earnings wouldn't be unreasonable.

Ok. Thanks, I see. Yes, then there is really quite a mistake in their model.

 

Another question to all of you, guys: If his assumption of a 6-7% growth rate and 0% reinvestment rate were actually true, what would be a proper p/e multiple in your opinion? 16? Surely not 12. The only thing BAC would have to do at this multiple is buying back stock all day.

 

If Mr Market calms down with regard to financials and BAC makes $2 eps growing 6% per year, where should the stock price be in a normal market environment?

 

Its not 2bucks and growing 6% that matters, its the 2 bucks and what the ROE on that retained book required to grown 6% a year that drives the valuation.  If I have to retain all of my capital to grow at 6% a year that's pretty crappy. If I only require a buck of retained earnings than I'm earning a smidge more than CoC and its worth smidge more than book (assume the return on my back book is similar)

 

growth is kinda sorta irrelevant for a bank because growth always requires capital.

[ni-co]

the multiple of earnings is more a function of ROE - both the current and normal ROE - mostly because ROE or marginal ROE is a really good measure of profitability. 

 

If you thought BAC was earning its normal ROE paying 10x earnings wouldn't be unreasonable.

Ok. Thanks, I see. Yes, then there is really quite a mistake in their model.

 

Another question to all of you, guys: If his assumption of a 6-7% growth rate and 0% reinvestment rate were actually true, what would be a proper p/e multiple in your opinion? 16? Surely not 12. The only thing BAC would have to do at this multiple is buying back stock all day.

 

If Mr Market calms down with regard to financials and BAC makes $2 eps growing 6% per year, where should the stock price be in a normal market environment?

 

Its not 2bucks and growing 6% that matters, its what the ROE on that retained book required to grown 6% a year that drives the valuation.  If I have to retain all of my capital to grow at 6% a year that's pretty crappy. If I only require a buck of retained earnings than I'm earning a smidge more than CoC and its worth smidge more than book (assume the return on my back book is similar)

 

growth is kinda sorta irrelevant for a bank because growth always requires capital.

 

ROE is itself a function of earnings growth and the reinvestment rate.

ROE = growth rate/reinvestment rate

In a business with a 0% reinvestment rate, your ROE is infinite, theoretically.

[topofeaturellc]

the multiple of earnings is more a function of ROE - both the current and normal ROE - mostly because ROE or marginal ROE is a really good measure of profitability. 

 

If you thought BAC was earning its normal ROE paying 10x earnings wouldn't be unreasonable.

Ok. Thanks, I see. Yes, then there is really quite a mistake in their model.

 

Another question to all of you, guys: If his assumption of a 6-7% growth rate and 0% reinvestment rate were actually true, what would be a proper p/e multiple in your opinion? 16? Surely not 12. The only thing BAC would have to do at this multiple is buying back stock all day.

 

If Mr Market calms down with regard to financials and BAC makes $2 eps growing 6% per year, where should the stock price be in a normal market environment?

 

Its not 2bucks and growing 6% that matters, its what the ROE on that retained book required to grown 6% a year that drives the valuation.  If I have to retain all of my capital to grow at 6% a year that's pretty crappy. If I only require a buck of retained earnings than I'm earning a smidge more than CoC and its worth smidge more than book (assume the return on my back book is similar)

 

growth is kinda sorta irrelevant for a bank because growth always requires capital.

 

ROE is itself a function of earnings growth and the reinvestment rate.

ROE = growth rate/reinvestment rate

In a business with a 0% reinvestment rate, your ROE is infinite, theoretically.

your book value growth is also zero.

[topofeaturellc]

for businesses that require capital to grow, growth is the dependent variable.

[Mephistopheles]

Yes and no. In this case they can get a lot of earnings growth when interest rates move up, LAS expenses come down, and they generally become more efficient.

[xazp]

That may be generally true but is not the case with BAC or C.  They have a lot of capital tied up in low/negative return loans from Countrywide, and they also have a lot of capital tied up in deferred tax assets.  As those loans are resolved and/or tax assets used, capital is freed up to be used for performing (higher return) loans. 

 

Here's an example. CRES (which handles all those foreclosures, etc), it has $23Bn of capital allocated to it, and has lost about $8Bn in the first half of the year.  The reason CRES needs so much capital is because Basel applies very high capital costs to non-performing loans and/or foreclosures.  So as they work through this mess, capital gets released.  And that means they can simply recycle their inefficiently used / negative return capital into something with a "+" sign on it. 

 

I think BAC and C each have tens of billions of dollars of capital that is getting run off and they can grow earnings simply from a) not losing money on that capital; and b) reinvesting it into something profitable. 

 

 

for businesses that require capital to grow, growth is the dependent variable.

[topofeaturellc]

That may be generally true but is not the case with BAC or C.  They have a lot of capital tied up in low/negative return loans from Countrywide, and they also have a lot of capital tied up in deferred tax assets.  As those loans are resolved and/or tax assets used, capital is freed up to be used for performing (higher return) loans. 

 

Here's an example. CRES (which handles all those foreclosures, etc), it has $23Bn of capital allocated to it, and has lost about $8Bn in the first half of the year.  The reason CRES needs so much capital is because Basel applies very high capital costs to non-performing loans and/or foreclosures.  So as they work through this mess, capital gets released.  And that means they can simply recycle their inefficiently used / negative return capital into something with a "+" sign on it. 

 

I think BAC and C each have tens of billions of dollars of capital that is getting run off and they can grow earnings simply from a) not losing money on that capital; and b) reinvesting it into something profitable. 

 

 

for businesses that require capital to grow, growth is the dependent variable.

 

Yes - there is a lot of capital there that can be redeployed - but that manifests itself as returns being lower than they should be normally.  Same with NIM issues.  But thats not "Growth" so much a mean reversion.

 

Also they are in theory overcapitalized which represents another way to get paid.

 

But the question of multiple is fundamentally one of the returns.  That's what I was addressing.    For a bank roe is a function of the funding costs of the deposit franchise. And then everything else is at the marginal rate. 

 

A non-deposit funded bank is worth tangible book because of that.  The question with BAC is really what is book at the end of everything, how much excess capital there is,  and how long does it take to reprice the assets and liabilities to earn the historic ROA.  Growth falls out from that.

 

I think the right way to think about multiple for a business is on earnings the reflect normal business, rather than what they happen to earn today.  And basically the multiple I'm willing to pay for that is a function of the incremental reinvestment economics

[xazp]

OK, so, unlike many people on this board, I think both Moynihan and the company are pretty mediocre.  My view, however, is that a mediocre-performing BAC still earnings $2/share+, and, their excess capital / capital generation provides upside, at a minimum, from buybacks. 

 

Moynihan has a target of ~14% ROTCE in 2016, which should get us near $2/share.  But what I don't know, and haven't seen BAC give guidance on, is whether they think that 14% is already completely mean-reverted, or if there's more gains above there to normalized.  I mean if they were operating with ROA's like WFC, they'd be earning something like $3/share. 

 

I don't have any way of knowing what normalized ROTCE or ROA would be for the company, I just know it's at or above their near-term target, but it makes a pretty big difference whether this is a $20, $25, or $30+ stock.  All of those numbers are above current share price so I am okay holding onto it. 

 

That may be generally true but is not the case with BAC or C.  They have a lot of capital tied up in low/negative return loans from Countrywide, and they also have a lot of capital tied up in deferred tax assets.  As those loans are resolved and/or tax assets used, capital is freed up to be used for performing (higher return) loans. 

 

Here's an example. CRES (which handles all those foreclosures, etc), it has $23Bn of capital allocated to it, and has lost about $8Bn in the first half of the year.  The reason CRES needs so much capital is because Basel applies very high capital costs to non-performing loans and/or foreclosures.  So as they work through this mess, capital gets released.  And that means they can simply recycle their inefficiently used / negative return capital into something with a "+" sign on it. 

 

I think BAC and C each have tens of billions of dollars of capital that is getting run off and they can grow earnings simply from a) not losing money on that capital; and b) reinvesting it into something profitable. 

 

 

for businesses that require capital to grow, growth is the dependent variable.

 

Yes - there is a lot of capital there that can be redeployed - but that manifests itself as returns being lower than they should be normally.  Same with NIM issues.  But thats not "Growth" so much a mean reversion.

 

Also they are in theory overcapitalized which represents another way to get paid.

 

But the question of multiple is fundamentally one of the returns.  That's what I was addressing.    For a bank roe is a function of the funding costs of the deposit franchise. And then everything else is at the marginal rate. 

 

A non-deposit funded bank is worth tangible book because of that.  The question with BAC is really what is book at the end of everything, how much excess capital there is,  and how long does it take to reprice the assets and liabilities to earn the historic ROA.  Growth falls out from that.

 

I think the right way to think about multiple for a business is on earnings the reflect normal business, rather than what they happen to earn today.  And basically the multiple I'm willing to pay for that is a function of the incremental reinvestment economics

[topofeaturellc]

OK, so, unlike many people on this board, I think both Moynihan and the company are pretty mediocre.  My view, however, is that a mediocre-performing BAC still earnings $2/share+, and, their excess capital / capital generation provides upside, at a minimum, from buybacks. 

 

Moynihan has a target of ~14% ROTCE in 2016, which should get us near $2/share.  But what I don't know, and haven't seen BAC give guidance on, is whether they think that 14% is already completely mean-reverted, or if there's more gains above there to normalized.  I mean if they were operating with ROA's like WFC, they'd be earning something like $3/share. 

 

I don't have any way of knowing what normalized ROTCE or ROA would be for the company, I just know it's at or above their near-term target, but it makes a pretty big difference whether this is a $20, $25, or $30+ stock.  All of those numbers are above current share price so I am okay holding onto it. 

 

That may be generally true but is not the case with BAC or C.  They have a lot of capital tied up in low/negative return loans from Countrywide, and they also have a lot of capital tied up in deferred tax assets.  As those loans are resolved and/or tax assets used, capital is freed up to be used for performing (higher return) loans. 

 

Here's an example. CRES (which handles all those foreclosures, etc), it has $23Bn of capital allocated to it, and has lost about $8Bn in the first half of the year.  The reason CRES needs so much capital is because Basel applies very high capital costs to non-performing loans and/or foreclosures.  So as they work through this mess, capital gets released.  And that means they can simply recycle their inefficiently used / negative return capital into something with a "+" sign on it. 

 

I think BAC and C each have tens of billions of dollars of capital that is getting run off and they can grow earnings simply from a) not losing money on that capital; and b) reinvesting it into something profitable. 

 

 

for businesses that require capital to grow, growth is the dependent variable.

 

Yes - there is a lot of capital there that can be redeployed - but that manifests itself as returns being lower than they should be normally.  Same with NIM issues.  But thats not "Growth" so much a mean reversion.

 

Also they are in theory overcapitalized which represents another way to get paid.

 

But the question of multiple is fundamentally one of the returns.  That's what I was addressing.    For a bank roe is a function of the funding costs of the deposit franchise. And then everything else is at the marginal rate. 

 

A non-deposit funded bank is worth tangible book because of that.  The question with BAC is really what is book at the end of everything, how much excess capital there is,  and how long does it take to reprice the assets and liabilities to earn the historic ROA.  Growth falls out from that.

 

I think the right way to think about multiple for a business is on earnings the reflect normal business, rather than what they happen to earn today.  And basically the multiple I'm willing to pay for that is a function of the incremental reinvestment economics

 

Oh profoundly mediocre might be too nice. And for the last few years the only US things I've owned were banks.  Mostly simpler regionals tho.  Esp the TARP warrants. But not this.

The simple question is what was ROTCE on the heritage bank assets that now make up BAC. I'd say WFC is irrelevant right?

 

Everything else is probably worth book. earns CoE on its tang book.

 

I've no idea if that adds up to 14% or even close.  I don't have the data in front of me but IIRC deposit funded banks are like 17% on average.

[xazp]

Well BAC does own some world-class businesses.  Wealth management is good and investment banking is a nice business in that you earn fee income without taking a lot of credit risk.  Both of these are world class and better than WFC. 

 

In addition, BAC's ability to attract deposits is also good, as is the breadth of their ATM network. 

 

However, in aggregate the company does not earn anything like the returns of WFC.  So where is the gap coming from? 

 

 

 

Oh profoundly mediocre might be too nice. And for the last few years the only US things I've owned were banks.  Mostly simpler regionals tho.  Esp the TARP warrants. But not this.

The simple question is what was ROTCE on the heritage bank assets that now make up BAC. I'd say WFC is irrelevant right?

 

Everything else is probably worth book. earns CoE on its tang book.

 

I've no idea if that adds up to 14% or even close.  I don't have the data in front of me but IIRC deposit funded banks are like 17% on average.

[ERICOPOLY]

However, in aggregate the company does not earn anything like the returns of WFC.  So where is the gap coming from? 

 

Wells Fargo's presentation:

 

page 11:  % of funding from deposits

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

page 12:  Net interest Margin

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

page 17:  Asset Productivity vs Peers  (higher fees as % of assets)

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

 

So JPM and BAC are nearly tied for asset productivity -- BAC has the edge, barely

 

[CorpRaider]

What regionals have you been in?  Ive been looking over sti and pnc.

[xazp]

They are a real outlier on efficiency ratio (p18).  Part of that is all the litigation and stuff, but, getting into the same area as C/JPM (not to mention WFC) would do great things for profits. 

 

However, in aggregate the company does not earn anything like the returns of WFC.  So where is the gap coming from? 

 

Wells Fargo's presentation:

 

page 11:  % of funding from deposits

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

page 12:  Net interest Margin

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

page 17:  Asset Productivity vs Peers  (higher fees as % of assets)

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

 

So JPM and BAC are nearly tied for asset productivity -- BAC has the edge, barely

[ERICOPOLY]

Consumer Real Estate Services should be profitable in Q4 this year.

 

It made $1b in Q2 after backing out $3.8b of litigation expenses.

[ERICOPOLY]

They are a real outlier on efficiency ratio (p18).  Part of that is all the litigation and stuff, but, getting into the same area as C/JPM (not to mention WFC) would do great things for profits. 

 

However, in aggregate the company does not earn anything like the returns of WFC.  So where is the gap coming from? 

 

Wells Fargo's presentation:

 

page 11:  % of funding from deposits

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

page 12:  Net interest Margin

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

page 17:  Asset Productivity vs Peers  (higher fees as % of assets)

https://www08.wellsfargomedia.com/downloads/pdf/invest_relations/presents/CS_021214.pdf

 

 

So JPM and BAC are nearly tied for asset productivity -- BAC has the edge, barely

 

Their "New BAC" is saving $1.8b a quarter in Q2, and they expect it to hit the $2b per quarter target in Q4.

 

Hopefully, they will launch a new initiative with new targets after meeting their initial goals.

[obtuse_investor]

If making it to the cover of a magazine is a sign of the peak, the latest economist cover should be a relief to everyone here.

 

Their cover is on the American government's "extortion racket". :-)