BAC-WT - Bank of America Warrants

[gary17]

i think we need multiple expansion & rate increase to have a home run on BAC  -  if both happens and one uses leverage , probably looking at 30 ~40% gain compounded over the next few years

 

if nothing happens , then probably 20% or so gain with leverage of commons , and around 17~18% for the warrants from $5.57 today....

[vinod1]

Outside of interest rate normalization I am having a tough time trying to bridge current TTM earnings of about $1.45 to $1.86 per share.

 

LAS expense reductions would net $1.6 billion.

 

But credit loss provisions are running at $2.6 billion annual rate. I do not think these would be sustainable over the next couple of years. Something in the range of $5 billion would need to be provisioned at a minimum - even this rate would be lower than BAC has achieved in the last 15 years. So this would be a drag of $2.4 billion annually relatively soon.

 

Litigation costs are already running rather low at $0.8 billion annual rate.

 

Do you guys see anything specific to BAC that would drive faster earnings growth compared to peers? 

 

Vinod

[jay21]

vinod - why higher for provisioning? I don't see charge-offs creeping up. Asset quality is still high. Not sure this will be a drag anytime soon.

 

Reasons for BAC having higher growth than peers have been discussed a few posts back.

[vinod1]

On another note, I think the tangible book value for BAC is a bit misleading when compared to others that do not have DTA. BAC has about $2.5 per share of DTA, so tangible book value ex-DTA is about $13 per share.

 

If you assume that LAS expenses goes away then BAC is earnings $1.55 per share or about 12% on TBV ex-DTA.

 

My point being,  if DTA goes away, Moynihan target of 12% return on TBV is achieved once additional LAS expenses go away.

 

Vinod

[vinod1]

vinod - why higher for provisioning? I don't see charge-offs creeping up. Asset quality is still high. Not sure this will be a drag anytime soon.

 

Reasons for BAC having higher growth than peers have been discussed a few posts back.

 

It is the nature of the credit cycle. Yes asset quality is high but that is always backward looking. We might see an year or so of lower credit costs but I would be surprised if they stay at this level for longer than that.

 

In 2011/2012 many have correctly assessed that credit costs would be low in a few years compared to what banks were charging at that time. Similarly, I think it would be prudent to expect higher costs in a couple of years from now. Credit costs are cyclical and we are past the low point already.

 

I look at Capital One's credit costs as they tend to lead the credit cycle and it is inching up.

 

 

As to higher growth for BAC, the ones mentioned, lower expenses, capital return and interest rates. Only interest rates can really move the needle for BAC.

 

I had 2x to 2.5x of my nominal portfolio value in BAC for most of the last few years before reducing it as it got close to $18 this year.

 

 

Vinod

[jay21]

vinod - why higher for provisioning? I don't see charge-offs creeping up. Asset quality is still high. Not sure this will be a drag anytime soon.

 

Reasons for BAC having higher growth than peers have been discussed a few posts back.

 

It is the nature of the credit cycle. Yes asset quality is high but that is always backward looking. We might see an year or so of lower credit costs but I would be surprised if they stay at this level for longer than that.

 

In 2011/2012 many have correctly assessed that credit costs would be low in a few years compared to what banks were charging at that time. Similarly, I think it would be prudent to expect higher costs in a couple of years from now. Credit costs are cyclical and we are past the low point already.

 

I look at Capital One's credit costs as they tend to lead the credit cycle and it is inching up.

 

 

As to higher growth for BAC, the ones mentioned, lower expenses, capital return and interest rates. Only interest rates can really move the needle for BAC.

 

I had 2x to 2.5x of my nominal portfolio value in BAC for most of the last few years before reducing it as it got close to $18 this year.

 

 

Vinod

 

I don't have too much insight into the C&I book but the real estate book is squeaky. There aren't as many high risk loans on the books based on LTVs, FICOs, exotic terms, etc. Also little to no risky prop trading, hedge funds, etc. They are pretty clean right now.

 

By looking at the past, you are overestimating the amount of provisioning needed. You need to compare current composition to the past. It's very different. (note: agree credit is a cycle, but just don't see it being too much in an upswing. the biggest issuers have been HY energy and they haven't hurt banks at all.)

[vinod1]

vinod - why higher for provisioning? I don't see charge-offs creeping up. Asset quality is still high. Not sure this will be a drag anytime soon.

 

Reasons for BAC having higher growth than peers have been discussed a few posts back.

 

It is the nature of the credit cycle. Yes asset quality is high but that is always backward looking. We might see an year or so of lower credit costs but I would be surprised if they stay at this level for longer than that.

 

In 2011/2012 many have correctly assessed that credit costs would be low in a few years compared to what banks were charging at that time. Similarly, I think it would be prudent to expect higher costs in a couple of years from now. Credit costs are cyclical and we are past the low point already.

 

I look at Capital One's credit costs as they tend to lead the credit cycle and it is inching up.

 

 

As to higher growth for BAC, the ones mentioned, lower expenses, capital return and interest rates. Only interest rates can really move the needle for BAC.

 

I had 2x to 2.5x of my nominal portfolio value in BAC for most of the last few years before reducing it as it got close to $18 this year.

 

 

Vinod

 

I don't have too much insight into the C&I book but the real estate book is squeaky. There aren't as many high risk loans on the books based on LTVs, FICOs, exotic terms, etc. Also little to no risky prop trading, hedge funds, etc. They are pretty clean right now.

 

By looking at the past, you are overestimating the amount of provisioning needed. You need to compare current composition to the past. It's very different. (note: agree credit is a cycle, but just don't see it being too much in an upswing. the biggest issuers have been HY energy and they haven't hurt banks at all.)

 

I am talking about very long term, not just during the great recession. Prop trading, hedge funds, etc did not lead to credit costs for BAC so really not relevant here.

 

Most of the credit costs are driven by credit cards which have high loss rates. Historically banks used to pound their chests when credit card costs went down below 5%. Now they are below 2.5%. This is way way off the charts in terms of credit performance.

 

Real estate, commercial RE, auto, etc are all not that extreme but close to historical low levels.

 

I would expect lower credit costs in future compared to be past but not at the current level. I just do not think they are sustainable.

 

Vinod

 

[ERICOPOLY]

I would think the top of the credit cycle would be the top of the economic cycle.

 

There appear to be a lot of indications that current times are not boom times.

 

One can imagine things getting worse, but one could also imagine things getting a lot better.  Sort of middle ground.

[vinod1]

Anecdotally underwriting is getting loose in autos and consumer RE from what I see here. That should translate into higher credit costs in future.

 

Vinod

[vinod1]

I would think the top of the credit cycle would be the top of the economic cycle.

 

There appear to be a lot of indications that current times are not boom times.

 

One can imagine things getting worse, but one could also imagine things getting a lot better.  Sort of middle ground.

 

I would think there are two factors that would impact credit costs

 

1. Underwriting quality of loans: More stringiest the criteria lower the costs. The criteria themselves would be impacted by economic cycle in general I think. As economy booms there would be a general lower of standards to go with the prevailing mood.

 

2. Economic conditions: Regardless of underwriting criteria, poor economic times should generate higher credit costs as more people/companies go bankrupt.

 

In general both 1 & 2 move together, but in this cycle, even if we did not really have boom times underwriting quality seems to have turned. We have managements complaining about this in auto loans and commercial RE. There might be others but I do not know.

 

So I am guessing that credit costs would go higher.

 

Vinod

[morningstar]

anyone know how much dividend the Fed  will approve based on current eps?

 

They need a minimum of 6% tier 1 common ratio in a severely adverse scenario.  BAC had excess capital of over $20 billion last year, so I don't think this will be a problem.

 

It is my understanding they can return all earnings from the previous 12 months as long as they meet the minimum capital requirement in severely adverse scenario.  Since BAC has earned over $16 billion over last 12 months I think they'll be able to return all of that to shareholders in dividends and buybacks.  I'm hoping for unchanged dividend and the rest in buybacks.

 

Given BAC's problems with the CCAR and generally high macro risk factors, it seems very unlikely the Fed would approve a 100% payout ratio - only a very few high-quality, low-risk banks have been approved for such. Nor do I think they'd ask for it - they still haven't managed to get through this process cleanly yet, I don't see asking for 100% as a smart call. Also the substantial RWA increases we saw as they approach exit from the parallel run - these model tweaks seem likely to absorb a good bit of the retained earnings this year.

 

All in all, I think that assuming much more than a 50% capital return ratio on a trailing basis is probably a fairly heroic estimate (and ahead of consensus - certainly reason to be bullish on the stock if you truly believe this).

[redskin]

anyone know how much dividend the Fed  will approve based on current eps?

 

They need a minimum of 6% tier 1 common ratio in a severely adverse scenario.  BAC had excess capital of over $20 billion last year, so I don't think this will be a problem.

 

It is my understanding they can return all earnings from the previous 12 months as long as they meet the minimum capital requirement in severely adverse scenario.  Since BAC has earned over $16 billion over last 12 months I think they'll be able to return all of that to shareholders in dividends and buybacks.  I'm hoping for unchanged dividend and the rest in buybacks.

 

Given BAC's problems with the CCAR and generally high macro risk factors, it seems very unlikely the Fed would approve a 100% payout ratio - only a very few high-quality, low-risk banks have been approved for such. Nor do I think they'd ask for it - they still haven't managed to get through this process cleanly yet, I don't see asking for 100% as a smart call. Also the substantial RWA increases we saw as they approach exit from the parallel run - these model tweaks seem likely to absorb a good bit of the retained earnings this year.

 

All in all, I think that assuming much more than a 50% capital return ratio on a trailing basis is probably a fairly heroic estimate (and ahead of consensus - certainly reason to be bullish on the stock if you truly believe this).

 

I think they will be asking for a high percentage of the trailing 12 months earnings considering they had excess capital of over $20 billion in last years CCAR.  Citigroup asked and received a 90% payout of trailing 12mo earnings last year even though they failed CCAR the previous year.

[redskin]

anyone know how much dividend the Fed  will approve based on current eps?

 

They need a minimum of 6% tier 1 common ratio in a severely adverse scenario.  BAC had excess capital of over $20 billion last year, so I don't think this will be a problem.

 

It is my understanding they can return all earnings from the previous 12 months as long as they meet the minimum capital requirement in severely adverse scenario.  Since BAC has earned over $16 billion over last 12 months I think they'll be able to return all of that to shareholders in dividends and buybacks.  I'm hoping for unchanged dividend and the rest in buybacks.

 

Given BAC's problems with the CCAR and generally high macro risk factors, it seems very unlikely the Fed would approve a 100% payout ratio - only a very few high-quality, low-risk banks have been approved for such. Nor do I think they'd ask for it - they still haven't managed to get through this process cleanly yet, I don't see asking for 100% as a smart call. Also the substantial RWA increases we saw as they approach exit from the parallel run - these model tweaks seem likely to absorb a good bit of the retained earnings this year.

 

All in all, I think that assuming much more than a 50% capital return ratio on a trailing basis is probably a fairly heroic estimate (and ahead of consensus - certainly reason to be bullish on the stock if you truly believe this).

 

BAC actually asked and received a payout ratio of over 80% last year based on trailing 12 months.

[Rasputin]

I'm a new member of this board and I would like to offer my scenario in bridging eps from $1.45 to 12% ROTCE.

 

1.  12% ROTCE

 

End of Q3 2015 TCE was $161 Billion.  12% of that = $19.3 Billion.  Divide that by 11.2 B fully diluted sh outstading = $1.72 eps.  The difference between 12% of $15.50 or $1.86 and $1.72 is mostly due to Berkshire's 700 million warrants, that's about 7% dilutive. 

 

2.  Bridging from $1.45 to $1.72 eps

 

A.  I"m going to assume similar interest rate environment, with bac management failing in their growth effort from 2016 to 2018.  So this will be what Brian call no revenue growth environment.  In this environment, Brian stated that he'd take out another $2 billion per year out of the core expense (ex litigation, LAS) - see Brian Moynihan Barclay presentation transcript September 17 2015.  In that transcript, he mentioned that BAC is now spending $3 billion per year on technology (he called it systems) vs $1.5 billion per year in 2010 and that he can walk it back to $1.5 billion.  I'm going to assume he walk it back over 3 years (2016-2018), generating $0.5 billion core expense reduction per year. 

 

B.  We know there is $100 million plus CCAR resubmission fees and $100 million per quarter expense in GWIM that will be gone next year.

 

C.  I'm going to divide Non interest expense into 3 buckets: Core, litigation, LAS

 

Year            Revenue            Core                                Litigation            LAS              Provision             

2015          $85 billion          $52.5                                  $1                      $3.6            $3.6

2016          $85 billion          $52.5-$0.1-$0.4-$0.5        $1                      $2.4            $3.6

2017          $85 billion          $51.5-$0.5                        $1                      $1.6            $3.6

2018          $85 billion          $51-$0.5                            $1                      $1.2            $3.6

 

By 2018, pretax earnings would be $28.7 billion.  30% tax rate gets us to $20.1 billion net income.  $1.54 billion dividend to preferred gets us $18.56 billion net income available to shareholders.

 

By then fully diluted shares outstanding should be around 10.85 billion.  Fully diluted eps = $1.71

 

Of course TCE would be higher than $161 billion by then since my capital return request model assume only 50% to 67% of previous year net income.

 

Capital return request:

Q32016 to Q22017 - $8 billion, $0.08 cent/quarter dividend + $4.5 billion share buyback (about 50% of 2015 net income)

Q32017 to Q22018 - $10.3 billion, $0.11 cent/quarter dividend + $5.5 billion share buyback (about 60% of 2016 net income)

Q32018 to Q22019 - $12 billion, $0.12 cent/quarter dividend + $6.8 billion sharebuyback (about 67% of 2017 net income)

 

Assuming, no changes in AOCI since interest rates are flat between now and 2018 in this scenario, TCE by Jan 2018 should be around $180 billion.  ROTCE will be 10.3% still below 12% target. 

 

So how much would you pay for a 100 plus year old business with #1 to #3 position in most of their businesses, 30% pretax margin currently, growing to 33.7% pretax margin by 2018, in a flat revenue environment (check out MSFT valuation, pretax margin and revenue growth/decline just for fun), with good moat (regulatory mostly, user of technology vs inventor of technology), that will be earning $1.54, $1.63, $1.72 eps over the next 3 years?  Bear in mind, 10 year treasury rate is at 2%, 30 year at 2.87%.  This business will grow earnings even faster as rates rise. 

 

Too bad BAC can't say revenue growth/decline ex changes in interest rate (companies with huge foreign revenues regularly report revenue growth/decline ex changes in currency as USD strengthen). 

 

[kevin4u2]

On another note, I think the tangible book value for BAC is a bit misleading when compared to others that do not have DTA. BAC has about $2.5 per share of DTA, so tangible book value ex-DTA is about $13 per share.

 

If you assume that LAS expenses goes away then BAC is earnings $1.55 per share or about 12% on TBV ex-DTA.

 

My point being,  if DTA goes away, Moynihan target of 12% return on TBV is achieved once additional LAS expenses go away.

 

Vinod

 

I don't understand your comment, "if DTA goes away".  Where is it going to go?

[ERICOPOLY]

DTA goes away when monetized and returned to shareholders.

[kevin4u2]

DTA goes away when monetized and returned to shareholders.

 

So how is the TBV for BAC misleading?  Is it or is it not an asset?

[ERICOPOLY]

It doesn't count towards capital, so it can be returned when monitized without hurting the capital ratios.

 

So it is a completely useless asset until monetized.

[vinod1]

I'm a new member of this board and I would like to offer my scenario in bridging eps from $1.45 to 12% ROTCE.

 

1.  12% ROTCE

 

End of Q3 2015 TCE was $161 Billion.  12% of that = $19.3 Billion.  Divide that by 11.2 B fully diluted sh outstading = $1.72 eps.  The difference between 12% of $15.50 or $1.86 and $1.72 is mostly due to Berkshire's 700 million warrants, that's about 7% dilutive. 

 

2.  Bridging from $1.45 to $1.72 eps

 

A.  I"m going to assume similar interest rate environment, with bac management failing in their growth effort from 2016 to 2018.  So this will be what Brian call no revenue growth environment.  In this environment, Brian stated that he'd take out another $2 billion per year out of the core expense (ex litigation, LAS) - see Brian Moynihan Barclay presentation transcript September 17 2015.  In that transcript, he mentioned that BAC is now spending $3 billion per year on technology (he called it systems) vs $1.5 billion per year in 2010 and that he can walk it back to $1.5 billion.  I'm going to assume he walk it back over 3 years (2016-2018), generating $0.5 billion core expense reduction per year. 

 

B.  We know there is $100 million plus CCAR resubmission fees and $100 million per quarter expense in GWIM that will be gone next year.

 

C.  I'm going to divide Non interest expense into 3 buckets: Core, litigation, LAS

 

Year            Revenue            Core                                Litigation            LAS              Provision             

2015          $85 billion          $52.5                                  $1                      $3.6            $3.6

2016          $85 billion          $52.5-$0.1-$0.4-$0.5        $1                      $2.4            $3.6

2017          $85 billion          $51.5-$0.5                        $1                      $1.6            $3.6

2018          $85 billion          $51-$0.5                            $1                      $1.2            $3.6

 

By 2018, pretax earnings would be $28.7 billion.  30% tax rate gets us to $20.1 billion net income.  $1.54 billion dividend to preferred gets us $18.56 billion net income available to shareholders.

 

By then fully diluted shares outstanding should be around 10.85 billion.  Fully diluted eps = $1.71

 

Of course TCE would be higher than $161 billion by then since my capital return request model assume only 50% to 67% of previous year net income.

 

Capital return request:

Q32016 to Q22017 - $8 billion, $0.08 cent/quarter dividend + $4.5 billion share buyback (about 50% of 2015 net income)

Q32017 to Q22018 - $10.3 billion, $0.11 cent/quarter dividend + $5.5 billion share buyback (about 60% of 2016 net income)

Q32018 to Q22019 - $12 billion, $0.12 cent/quarter dividend + $6.8 billion sharebuyback (about 67% of 2017 net income)

 

Assuming, no changes in AOCI since interest rates are flat between now and 2018 in this scenario, TCE by Jan 2018 should be around $180 billion.  ROTCE will be 10.3% still below 12% target. 

 

So how much would you pay for a 100 plus year old business with #1 to #3 position in most of their businesses, 30% pretax margin currently, growing to 33.7% pretax margin by 2018, in a flat revenue environment (check out MSFT valuation, pretax margin and revenue growth/decline just for fun), with good moat (regulatory mostly, user of technology vs inventor of technology), that will be earning $1.54, $1.63, $1.72 eps over the next 3 years?  Bear in mind, 10 year treasury rate is at 2%, 30 year at 2.87%.  This business will grow earnings even faster as rates rise. 

 

Too bad BAC can't say revenue growth/decline ex changes in interest rate (companies with huge foreign revenues regularly report revenue growth/decline ex changes in currency as USD strengthen).

 

Rasputin,

 

Welcome to the board. A very good post and hope you participate more.

 

My numbers are slightly different but I think are roughly in the same ball park. A few differences and I end up with slightly higher EPS that you over the next 3 years.

 

1. Buffett's warrants need to be included. They would dilute by about 500 million shares assuming an exercise price of around $22.

 

2. Some organic growth is likely, you can put in a modest growth in loans to get a conservative estimate.

 

3. Provision expenses are likely to be higher than the current rate over next 2 to 3 years. Historically, a 1% loss rate used to be a rough first cut estimate for most banks (without adjusting for differences in types of loans). This is something Buffett has also used in the past and a number of others have estimated as well (Dimon, Richard Davis of US Bancorp). This is an over the cycle average and we are at the low point of the cycle now.

 

At 0.3% loan loss provisions, BAC has probably hit the low point of the cycle last year. It is now at 0.4% and likely to remain at that level for the next several quarters. But it is likely to move higher after that. So you need to model that increase. I would be surprised if it is not $5 or $6 billion in 2018.

 

A lot of loans that were written in 2008 to 2010 were written very conservatively and using an average term of 5 years it is not surprising to see the low point of credit losses in 2014.

 

4. I am surprised to see LAS expenses going further down from $2 billion. I thought that was the steady state level for BAC and I have not seen any plans/comments about bringing it down much below that level. How did you estimate this?

 

5. I saw Moynihan comments about tech spending and he said that "we can take it back down" if needed but I think they have still a lot of integration work left to be done. Most of the data is still siloed and they need to spend a lot to catch up with JP Morgan and Wells Fargo to get to a more unified customer view that is needed if they have any hope of cross sell.

 

Vinod

 

[Granitepost]

Hi Vinod: 

"When Bank of America (NYSE:BAC) was in deep trouble following the financial crisis, Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) came to the rescue with an enormous investment in the struggling bank. Part of this investment was the right to purchase 700 million shares of BAC at a strike price of $7.14 via warrants that expire in 2021. "

See: http://seekingalpha.com/article/2062273-buy-bank-of-america-like-buffett-warrants-offer-tremendous-value

Cheers, Granitepost

[ourkid8]

I am hoping BAC's management/Buffett turns this into a cashless transaction thus not diluting current shareholders by 700 million shares.  Buffett has done this with other transactions as well so there is precedence. 

 

Hi Vinod: 

"When Bank of America (NYSE:BAC) was in deep trouble following the financial crisis, Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) came to the rescue with an enormous investment in the struggling bank. Part of this investment was the right to purchase 700 million shares of BAC at a strike price of $7.14 via warrants that expire in 2021. "

See: http://seekingalpha.com/article/2062273-buy-bank-of-america-like-buffett-warrants-offer-tremendous-value

Cheers, Granitepost

[gary17]

So seems like everyone is modelling around 1.8 EPS by end of 2018

 

at 11pe x 1.8 eps = $20  the warrants will be very poor investment

 

$20 - $13 strike = $7

 

$ 7 / $5.55  today is about 7% compound return until January 2019 !   

 

 

The only upside I see then is if the interest rate moves.

 

Gary

[ERICOPOLY]

So seems like everyone is modelling around 1.8 EPS by end of 2018

 

at 11pe x 1.8 eps = $20  the warrants will be very poor investment

 

$20 - $13 strike = $7

 

$ 7 / $5.55  today is about 7% compound return until January 2019 !   

 

 

The only upside I see then is if the interest rate moves.

 

Gary

 

Don't forget to include the earnings between now and then.

 

So at your P/E 11x, by end of 2018 it would be maybe $1.50+$1.60+$1.70 in earnings over that period.

 

So $20+$4.80= $24.80.

[KCLarkin]

7% return plus a free option on interest rate normalization doesn't sound bad. The second half of this exercise would be to calculate EPS assuming some normalization in NIM. And estimate a probability of this occurring.

 

 

 

[gary17]

So seems like everyone is modelling around 1.8 EPS by end of 2018

 

at 11pe x 1.8 eps = $20  the warrants will be very poor investment

 

$20 - $13 strike = $7

 

$ 7 / $5.55  today is about 7% compound return until January 2019 !   

 

 

The only upside I see then is if the interest rate moves.

 

Gary

 

Don't forget to include the earnings between now and then.

 

So at your P/E 11x, by end of 2018 it would be maybe $1.50+$1.60+$1.70 in earnings over that period.

 

So $20+$4.80= $24.80.

 

Eric , what you say makes sense !

 

But I am simply thinking this:  this is now year 2018....  EPS is $1.7....  so the market valuation is 11x  ( 12.5 x for WFC)      so it should trade at 11x 1.7 in 2018... 

 

At $24.80 / 11  implies EPS of $2.25 by 2018 , no ?