BAC-WT - Bank of America Warrants

[DCG]

Small pet peeve..can someone change this tread title to just be the BAC thread, since 90% of this nearly 600-page thread is not related to the actual warrants?

[vinod1]

The real question around the 2017 Leaps is if the stock will rise enough in two years to make them worthwhile. 

 

We had a couple of legal settlements again last week, related to the fx price fixing.  As long as this overhang is still around, we wont see alot of price appreciation.  300 m here, 300 m there, adds up. 

More than the cash is the reputation damage.  Until there are a clear two or three quarters of results, a dividend increase toward what JPM and WFC payout, and some buybacks, I dont see the stock going up too fast.  It would be nice but I have learned to temper my expectations. 

 

I am neither buying nor selling my existing Leaps, in any big way, subject to change if there is a correction or run-up.

 

I owe you and Eric a big thanks for explaining LEAPS. It has made a huge difference to my returns. Eric, among other things, for pointing out that the biggest returns are likely to come early on and that LEAPS would be the ideal way to capture that portion of the gain. Your comments to the effect that "get rid of buy and hold mentality with LEAPS" got me to be more opportunistic in taking advantage of market swings rather than acting with LEAPS just as if I own stock directly. Motto became "Think long term, act short term".

 

Vinod

[redskin]

Is there a significant margin of safety still in BAC?

 

It had been a return to mediocrity thesis and as it got closer to $20, I have reduced my allocation to a fraction of the earlier size. As the allocation had primarily been in LEAP's, the risk reward does not seem so overwhelmingly attractive as before.

 

My own expectations for earnings were something like below

 

2015 $1.5 to $1.6

2016 $1.7 to $1.9

2017 $1.9 to $2.1

 

Please see attached document for a little more detail. I expect normalized cycle average losses to be around $7 to $8 billion, much more than the estimates in the document, but the next few years should see below average losses simply due to the stage of the credit cycle we are at.

 

To me it looks like this is at most a 15% annual gain type of investment over the next few years. Say to $25 in three years or $33 in five under reasonable expectations.

 

What are your earnings expectations and do you see BAC earning much more over the next few years?

 

Thanks

 

Vinod

 

If you look at Q3 earnings and plug in a break even performance for CRES, net income for the company would be nearly $5 billion.  I think this is a good way to determine what 'normalized earnings' should be.  In time, CRES will make a reasonable return.  The large litigation expenses in CRES are done and LAS expense continues to fall.  I think the $5 billion number is a good base for 'normalized earnings'.  Eventually, I think ROA of 1.25% should be achievable.

 

In addition, assets should stabilize and then grow with the growth in the economy.  As Moynihan has mentioned, the business does not need any more capital, thus any earnings should be available to shareholders.  I would hope they repurchase somewhere around $5 billion shares next year and $10 billion+ the following.  With normalized earnings and share buybacks, I don't think it's unreasonable to see earnings of $2.50-3 in the next few years.  I think the current stock price does provide a margin of safety even if my assumptions are too optimistic.

 

 

 

[vinod1]

Is there a significant margin of safety still in BAC?

 

It had been a return to mediocrity thesis and as it got closer to $20, I have reduced my allocation to a fraction of the earlier size. As the allocation had primarily been in LEAP's, the risk reward does not seem so overwhelmingly attractive as before.

 

My own expectations for earnings were something like below

 

2015 $1.5 to $1.6

2016 $1.7 to $1.9

2017 $1.9 to $2.1

 

Please see attached document for a little more detail. I expect normalized cycle average losses to be around $7 to $8 billion, much more than the estimates in the document, but the next few years should see below average losses simply due to the stage of the credit cycle we are at.

 

To me it looks like this is at most a 15% annual gain type of investment over the next few years. Say to $25 in three years or $33 in five under reasonable expectations.

 

What are your earnings expectations and do you see BAC earning much more over the next few years?

 

Thanks

 

Vinod

 

If you look at Q3 earnings and plug in a break even performance for CRES, net income for the company would be nearly $5 billion.  I think this is a good way to determine what 'normalized earnings' should be.  In time, CRES will make a reasonable return.  The large litigation expenses in CRES are done and LAS expense continues to fall.  I think the $5 billion number is a good base for 'normalized earnings'.  Eventually, I think ROA of 1.25% should be achievable.

 

 

I try to estimate BAC from 5-6 different angles and this is one approach that I had also used. You do need to make two adjustments to the Q3 numbers

 

1. Loan loss provisions of $0.6 billion is at an annual rate are at a multi-decade low as a percentage of loans. Even at previous cycle lows in 2004 and 2007, it was at a much higher level. My estimate of normal loan loss provisions is around $1.75 billion to $2 billion per quarter. You can get this number from several different ways as well - management comments, weighted average loan losses per each loan type using historical averages, comparable company estimates of normal levels (Dimon's estimate in AR), etc.

 

2. There is an annual retirement contribution of $0.9 billion in every first quarter of the year. You need to incorporate this into the quarterly numbers.

 

If you make these two adjustments after tax, Q3 shows $4 billion in earnings.

 

Vinod

 

[redskin]

Is there a significant margin of safety still in BAC?

 

It had been a return to mediocrity thesis and as it got closer to $20, I have reduced my allocation to a fraction of the earlier size. As the allocation had primarily been in LEAP's, the risk reward does not seem so overwhelmingly attractive as before.

 

My own expectations for earnings were something like below

 

2015 $1.5 to $1.6

2016 $1.7 to $1.9

2017 $1.9 to $2.1

 

Please see attached document for a little more detail. I expect normalized cycle average losses to be around $7 to $8 billion, much more than the estimates in the document, but the next few years should see below average losses simply due to the stage of the credit cycle we are at.

 

To me it looks like this is at most a 15% annual gain type of investment over the next few years. Say to $25 in three years or $33 in five under reasonable expectations.

 

What are your earnings expectations and do you see BAC earning much more over the next few years?

 

Thanks

 

Vinod

 

If you look at Q3 earnings and plug in a break even performance for CRES, net income for the company would be nearly $5 billion.  I think this is a good way to determine what 'normalized earnings' should be.  In time, CRES will make a reasonable return.  The large litigation expenses in CRES are done and LAS expense continues to fall.  I think the $5 billion number is a good base for 'normalized earnings'.  Eventually, I think ROA of 1.25% should be achievable.

 

 

I try to estimate BAC from 5-6 different angles and this is one approach that I had also used. You do need to make two adjustments to the Q3 numbers

 

1. Loan loss provisions of $0.6 billion is at an annual rate are at a multi-decade low as a percentage of loans. Even at previous cycle lows in 2004 and 2007, it was at a much higher level. My estimate of normal loan loss provisions is around $1.75 billion to $2 billion per quarter. You can get this number from several different ways as well - management comments, weighted average loan losses per each loan type using historical averages, comparable company estimates of normal levels (Dimon's estimate in AR), etc.

 

2. There is an annual retirement contribution of $0.9 billion in every first quarter of the year. You need to incorporate this into the quarterly numbers.

 

If you make these two adjustments after tax, Q3 shows $4 billion in earnings.

 

Vinod

 

Good points.  Thanks.  I would agree that charge offs will probably average .75-1% of loans.  I do think the next several years will continue to be below average due to high credit standards.

[ERICOPOLY]

Small pet peeve..can someone change this tread title to just be the BAC thread, since 90% of this nearly 600-page thread is not related to the actual warrants?

 

Ironically, when I actually talked about the warrants on this thread people squealed. 

 

So we then had to create that "BAC leverage" thread over under the "Strategies" category where we could then discuss warrants.  Because one wouldn't want to discuss warrants under a thread titled BAC-WT  ::)

[vinod1]

Is there a significant margin of safety still in BAC?

 

It had been a return to mediocrity thesis and as it got closer to $20, I have reduced my allocation to a fraction of the earlier size. As the allocation had primarily been in LEAP's, the risk reward does not seem so overwhelmingly attractive as before.

 

My own expectations for earnings were something like below

 

2015 $1.5 to $1.6

2016 $1.7 to $1.9

2017 $1.9 to $2.1

 

Please see attached document for a little more detail. I expect normalized cycle average losses to be around $7 to $8 billion, much more than the estimates in the document, but the next few years should see below average losses simply due to the stage of the credit cycle we are at.

 

To me it looks like this is at most a 15% annual gain type of investment over the next few years. Say to $25 in three years or $33 in five under reasonable expectations.

 

What are your earnings expectations and do you see BAC earning much more over the next few years?

 

Thanks

 

Vinod

 

In addition, assets should stabilize and then grow with the growth in the economy.  As Moynihan has mentioned, the business does not need any more capital, thus any earnings should be available to shareholders.  I would hope they repurchase somewhere around $5 billion shares next year and $10 billion+ the following.  With normalized earnings and share buybacks, I don't think it's unreasonable to see earnings of $2.50-3 in the next few years.  I think the current stock price does provide a margin of safety even if my assumptions are too optimistic.

 

BAC prior to ML acquisition averaged a ROA of 1.3% from 1998 to 2006 (with lots of help from housing bubble, prior to CARD act that cut down maybe $5 billion or so in revenues and various other limitations on charges that banks used to routinely make). Investment banks earn much lower ROA, below 1%. If you take these into account BAC would likely be able to earn 1% ROA going forward on a normalized basis.

 

If you estimate 5 years out. Assets grow 4% annually to $2.6 tiillion, they spend $50 billion in buybacks over these 5 years and net $40 billion buybacks (to account for share dilution from options, etc) and pay $24 on average to retire 1.7 billion shares to end with 9.6 billion shares outstanding. At a 1% ROA, it earns $26 billion or $2.7 per share. That is 5 years from now and assumes pretty smooth going with no recession or any other hiccup. You are looking at most a double in five years. Not bad, but not particularly table pounding investment choice either.

 

As to 1% ROA, management in 2013, Q4 made comments that a 1% ROA is what their goal is for 3 years and further clarified that 1% is at the very end of the 3 years. They threw in caveats about more normal interest rates, etc. So I think any estimate of ROA above 1% might be too optimistic.

 

Vinod

[ERICOPOLY]

I agree that banks deserve a higher multiple going forward. I think however that it might take a long time on the order of 5-7 years for this re-rating to take place.

 

Could be 5-7.

 

I'm not clear as to why yet though.  We're coming up on 2015... if there are no more financial-crisis lawsuits filed by 2018 it will all be in the past sheltered by the maximum 10 yr statute of limitations.  So that's in 3 years.  And with each year ticking by, a year's worth of liability slips into oblivion.  For example, we're no longer liable for things done in 2004 and prior.  Next year 2005, then 2006, then 2007.  That's my thinking.

 

It looks like they're already settled anyhow, but I still feel like they'll find a new way to sue.

 

[redskin]

Is there a significant margin of safety still in BAC?

 

It had been a return to mediocrity thesis and as it got closer to $20, I have reduced my allocation to a fraction of the earlier size. As the allocation had primarily been in LEAP's, the risk reward does not seem so overwhelmingly attractive as before.

 

My own expectations for earnings were something like below

 

2015 $1.5 to $1.6

2016 $1.7 to $1.9

2017 $1.9 to $2.1

 

Please see attached document for a little more detail. I expect normalized cycle average losses to be around $7 to $8 billion, much more than the estimates in the document, but the next few years should see below average losses simply due to the stage of the credit cycle we are at.

 

To me it looks like this is at most a 15% annual gain type of investment over the next few years. Say to $25 in three years or $33 in five under reasonable expectations.

 

What are your earnings expectations and do you see BAC earning much more over the next few years?

 

Thanks

 

Vinod

 

In addition, assets should stabilize and then grow with the growth in the economy.  As Moynihan has mentioned, the business does not need any more capital, thus any earnings should be available to shareholders.  I would hope they repurchase somewhere around $5 billion shares next year and $10 billion+ the following.  With normalized earnings and share buybacks, I don't think it's unreasonable to see earnings of $2.50-3 in the next few years.  I think the current stock price does provide a margin of safety even if my assumptions are too optimistic.

 

BAC prior to ML acquisition averaged a ROA of 1.3% from 1998 to 2006 (with lots of help from housing bubble, prior to CARD act that cut down maybe $5 billion or so in revenues and various other limitations on charges that banks used to routinely make). Investment banks earn much lower ROA, below 1%. If you take these into account BAC would likely be able to earn 1% ROA going forward on a normalized basis.

 

If you estimate 5 years out. Assets grow 4% annually to $2.6 tiillion, they spend $50 billion in buybacks over these 5 years and net $40 billion buybacks (to account for share dilution from options, etc) and pay $24 on average to retire 1.7 billion shares to end with 9.6 billion shares outstanding. At a 1% ROA, it earns $26 billion or $2.7 per share. That is 5 years from now and assumes pretty smooth going with no recession or any other hiccup. You are looking at most a double in five years. Not bad, but not particularly table pounding investment choice either.

 

As to 1% ROA, management in 2013, Q4 made comments that a 1% ROA is what their goal is for 3 years and further clarified that 1% is at the very end of the 3 years. They threw in caveats about more normal interest rates, etc. So I think any estimate of ROA above 1% might be too optimistic.

 

Vinod

 

The benefit of rising rates is discussed often.  What about the possibility of the sluggish economy turning more positive?  Do you think it's possible to see the loan book increase from $900 billion to $1,100 billion over 3 years if the economy takes off?  How much would that help profitability?

 

I think it is a good investment with a continued sluggish economy and low interest rates.  It could be an exceptional investment with a strong economy and increased interest rates.

[KCLarkin]

The benefit of rising rates is discussed often.  What about the possibility of the sluggish economy turning more positive?  Do you think it's possible to see the loan book increase from $900 billion to $1,100 billion over 3 years if the economy takes off?  How much would that help profitability?

 

I think it is a good investment with a continued sluggish economy and low interest rates.  It could be an exceptional investment with a strong economy and increased interest rates.

 

I read a research paper a few months ago that suggested banks are more sensitive to economic growth than they are to interest rates.

[vinod1]

I agree that banks deserve a higher multiple going forward. I think however that it might take a long time on the order of 5-7 years for this re-rating to take place.

 

Could be 5-7.

 

I'm not clear as to why yet though.  We're coming up on 2015... if there are no more financial-crisis lawsuits filed by 2018 it will all be in the past sheltered by the maximum 10 yr statute of limitations.  So that's in 3 years.  And with each year ticking by, a year's worth of liability slips into oblivion.  For example, we're no longer liable for things done in 2004 and prior.  Next year 2005, then 2006, then 2007.  That's my thinking.

 

It looks like they're already settled anyhow, but I still feel like they'll find a new way to sue.

 

I did not know about the 10 yr statute of limitations. But lawsuits aside, even when banks report more normal earnings, I presume the scars from the financial crisis would dilute the low leverage factor on the multiple that investors assign to bank stocks.

 

Vinod

[vinod1]

Is there a significant margin of safety still in BAC?

 

It had been a return to mediocrity thesis and as it got closer to $20, I have reduced my allocation to a fraction of the earlier size. As the allocation had primarily been in LEAP's, the risk reward does not seem so overwhelmingly attractive as before.

 

My own expectations for earnings were something like below

 

2015 $1.5 to $1.6

2016 $1.7 to $1.9

2017 $1.9 to $2.1

 

Please see attached document for a little more detail. I expect normalized cycle average losses to be around $7 to $8 billion, much more than the estimates in the document, but the next few years should see below average losses simply due to the stage of the credit cycle we are at.

 

To me it looks like this is at most a 15% annual gain type of investment over the next few years. Say to $25 in three years or $33 in five under reasonable expectations.

 

What are your earnings expectations and do you see BAC earning much more over the next few years?

 

Thanks

 

Vinod

 

In addition, assets should stabilize and then grow with the growth in the economy.  As Moynihan has mentioned, the business does not need any more capital, thus any earnings should be available to shareholders.  I would hope they repurchase somewhere around $5 billion shares next year and $10 billion+ the following.  With normalized earnings and share buybacks, I don't think it's unreasonable to see earnings of $2.50-3 in the next few years.  I think the current stock price does provide a margin of safety even if my assumptions are too optimistic.

 

BAC prior to ML acquisition averaged a ROA of 1.3% from 1998 to 2006 (with lots of help from housing bubble, prior to CARD act that cut down maybe $5 billion or so in revenues and various other limitations on charges that banks used to routinely make). Investment banks earn much lower ROA, below 1%. If you take these into account BAC would likely be able to earn 1% ROA going forward on a normalized basis.

 

If you estimate 5 years out. Assets grow 4% annually to $2.6 tiillion, they spend $50 billion in buybacks over these 5 years and net $40 billion buybacks (to account for share dilution from options, etc) and pay $24 on average to retire 1.7 billion shares to end with 9.6 billion shares outstanding. At a 1% ROA, it earns $26 billion or $2.7 per share. That is 5 years from now and assumes pretty smooth going with no recession or any other hiccup. You are looking at most a double in five years. Not bad, but not particularly table pounding investment choice either.

 

As to 1% ROA, management in 2013, Q4 made comments that a 1% ROA is what their goal is for 3 years and further clarified that 1% is at the very end of the 3 years. They threw in caveats about more normal interest rates, etc. So I think any estimate of ROA above 1% might be too optimistic.

 

Vinod

 

The benefit of rising rates is discussed often.  What about the possibility of the sluggish economy turning more positive?  Do you think it's possible to see the loan book increase from $900 billion to $1,100 billion over 3 years if the economy takes off?  How much would that help profitability?

 

I think it is a good investment with a continued sluggish economy and low interest rates.  It could be an exceptional investment with a strong economy and increased interest rates.

 

I agree that is possible. I think in the 2010 investor conference, they came up with the $45 to $50 billion PTPP income so in a robust business/interest rate environment there would be significant upside to my estimates.

 

I had a portfolio exposure of about 80% or 90% nominal at my peak, I have reduced it significantly as the stock rallied to the mid $17s. I am just trying to size my exposure at this point.

 

Vinod

[ERICOPOLY]

I agree that banks deserve a higher multiple going forward. I think however that it might take a long time on the order of 5-7 years for this re-rating to take place.

 

Could be 5-7.

 

I'm not clear as to why yet though.  We're coming up on 2015... if there are no more financial-crisis lawsuits filed by 2018 it will all be in the past sheltered by the maximum 10 yr statute of limitations.  So that's in 3 years.  And with each year ticking by, a year's worth of liability slips into oblivion.  For example, we're no longer liable for things done in 2004 and prior.  Next year 2005, then 2006, then 2007.  That's my thinking.

 

It looks like they're already settled anyhow, but I still feel like they'll find a new way to sue.

 

I did not know about the 10 yr statute of limitations. But lawsuits aside, even when banks report more normal earnings, I presume the scars from the financial crisis would dilute the low leverage factor on the multiple that investors assign to bank stocks.

 

Vinod

 

It is FIRREA that carries 10 yr statute.  Triple damages.  It's a really ugly thing to tangle with.

 

What you say about the scars from the financial crisis makes sense to me, except... look at how badly the small cap index got whacked in 2008/2009, and now look at it today?  These people have short memories.  Leading me to believe that their issue with banks has to be either litigation or related to ever-increasing capital demands by regulators.

 

 

[txlaw]

I agree that banks deserve a higher multiple going forward. I think however that it might take a long time on the order of 5-7 years for this re-rating to take place.

 

Could be 5-7.

 

I'm not clear as to why yet though.  We're coming up on 2015... if there are no more financial-crisis lawsuits filed by 2018 it will all be in the past sheltered by the maximum 10 yr statute of limitations.  So that's in 3 years.  And with each year ticking by, a year's worth of liability slips into oblivion.  For example, we're no longer liable for things done in 2004 and prior.  Next year 2005, then 2006, then 2007.  That's my thinking.

 

It looks like they're already settled anyhow, but I still feel like they'll find a new way to sue.

 

One thing to keep in mind re: civil litigation.  Tolling agreements have likely been signed. 

 

So you can't really just mechanically tick off years of liability for past malfeasance.

[karthikpm]

Are the warrants getting cheap again?

[bobp]

These A warrants are really lagging now. In March the common traded this high and the wt was at about 8 1/2. They've lost 9 months or so of time, but still. It's like over the last month someone's decided to sell millions.

[rpadebet]

These A warrants are really lagging now. In March the common traded this high and the wt was at about 8 1/2. They've lost 9 months or so of time, but still. It's like over the last month someone's decided to sell millions.

 

The warrants can lag even more. The cost of leverage as I calculate now is around 5.3%. Other bank warrants have traded close to 4% cost of leverage, so at equivalent cost of leverage, the warrants could be priced as low as 6.45 now.

[LC]

Interesting how relatively poor the warrants have been as an investment, since Plan wrote that blog post many moons ago...

[ERICOPOLY]

Interesting how relatively poor the warrants have been as an investment, since Plan wrote that blog post many moons ago...

 

Do you have a link to it?

[Liberty]

Interesting how relatively poor the warrants have been as an investment, since Plan wrote that blog post many moons ago...

 

Do you have a link to it?

 

https://variantperceptions.wordpress.com/2012/01/19/bank-of-america-big-improvement/

 

http://variantperceptions.wordpress.com/2010/08/29/francis-chou-on-large-bank-warrants/

 

http://variantperceptions.wordpress.com/2012/04/01/tarp-warrants-let-every-eye-negotiate-for-itself/

[ni-co]

Interesting how relatively poor the warrants have been as an investment, since Plan wrote that blog post many moons ago...

 

Do you have a link to it?

 

https://variantperceptions.wordpress.com/2012/01/19/bank-of-america-big-improvement/

 

http://variantperceptions.wordpress.com/2010/08/29/francis-chou-on-large-bank-warrants/

 

http://variantperceptions.wordpress.com/2012/04/01/tarp-warrants-let-every-eye-negotiate-for-itself/

 

This might have to to with the way standard option pricing models work. Volatility has been incredibly low for months now.

[ERICOPOLY]

Investor Relations page has a link to Moynihan's talk today: a webcast.

[meiroy]

"Near-term revenue headwinds

– 4Q sales & trading revenue expected to be down linked-quarter and year-over-year

– Interest rates remain low, negatively impacting net interest income

– BAC credit spreads have tightened, which results in a negative debit valuation adjustment (DVA)"

 

[fareastwarriors]

Bank of America Gives Weak Outlook for Trading Revenue

 

Bank’s Shares Drop After CEO Speaks at Industry Conference

 

 

 

http://www.wsj.com/articles/bank-of-america-gives-weak-outlook-for-trading-revenue-1418136559?mod=WSJ_hp_LEFTWhatsNewsCollection

[Uccmal]

My how have things changed.  The CEO reigns in expectations.  The markets tanking.  The price of oil is cliff diving. 

 

Meanwhile BAC is.....  Neutral?