BAC-WT - Bank of America Warrants

[vinod1]

To those who have not decreased their BAC exposure, what is your exposure as a % of portfolio?

 

I had more than 100% nominal exposure (LEAPS, Warrants & Stock) to BAC when it is at $7 and under. Reduced it about 5% range (stock only) at $17.

 

Increased to 25% to 30% of portfolio in the $12 range. Now reduced it to 5% range in high $18's.

 

Not trying to be a market timer, but it seems logical to increase or reduce allocation based on price/IV. I would think lots of board members would be doing the same, but it does not seem to be the case.

 

Vinod

[onyx1]

Gundlach: Trump victory sets stage for massive bond bear market

 

"Look for Trump to "amp up the deficit" to pay for infrastructure and other programs - producing an inflation rate of 3% and nominal GDP growth of 4-6%. Given that, there's no way the 10-year Treasury yield stays near its current level of 2.15%, and it could rise as high as 6% in the next four or five years."

 

 

What might this mean for BAC earnings and valuation?  Here is a back of the envelop estimate:

Q3 2016 run rate earning are $1.65/share

 

After 3 years of 5% GDP growth, $1.65/share grows to $1.82/share

 

At the end of Q3 2016, BAC declared a positive 100bp parallel yield curve shift would add $5.3 bln in PT earnings

 

Assuming BAC reduces curve exposure as rate rise, I'll assume the following:

 

1st 100bp = $5.3 bln

2nd 100bp = $4.0 bln

3rd 100bp = $3.0 bln

 

With a 300bp parallel move from here, the 10-year Treasury would be around 5.15% (it closed at 1.60% on 9/30), BAC would add $12.3 bln to PT earnings.

 

After tax (assuming 35% rate) $12.3*.65 = $8bln, or an additional EPS of $8/11= $0.73/share

 

$1.82 + $0.73 = $2.55/ share

 

I assume the planned & announced reduction in expenses will offset a likely increase in provisions necessary from higher growth.

 

With core earnings growing at 5% and reported earning growing at 15%, a reasonable multiple is 14x.

 

$2.55 x 14 = $35.70 /share in three years

 

And that doesn't even include the $1-$2 /share they have in existing DTA assets that will be converted into cash over this period.

 

I would love to have your scenario play out as a BAC investor. I might even put a Trump bumper sticker in that case. :) But I think you are ignoring 2nd order effects.

 

1. The spectacularly low interest rates have a corresponding parallel in spectacularly low loan loss rates. Provision for loan losses are running at about 0.4% level or about $3 billion. Normalized they are more likely to be in the $7 to $8 billion range. When interest rates increase we are also likely to have higher loan loss rates for various reasons. This is likely to knock off $4 to $5 billion from your estimates.

 

2. Interest rates going up by say 3% would reduce mortgage production income as there would be fewer people who would be taking out mortgages and mortgage refinancing would be close to shutdown. It would also depress housing prices significantly with its own negative consequences.

 

3. They would also incur losses on their securities portfolio during this period of rising rates. This is not going to hurt long term earnings power, but it would impact net income and book value during the transition period.

 

Overall, increases in interest rates (more accurately a steep yield curve) would be beneficial to the banks. just not as much as you extrapolate from company exposure to a 100 bps shift in interest rates.

 

Vinod

 

Vinod,  Thanks for the morning chuckle!

 

FWIW, the last I heard BAC give an indication of normalized provisions is $1.5bln per quarter but that was in 2013.  I assumed that number, and that the increase was offset by the planned expense reduction announced last quarter where non-interest expenses will drop almost $3bln from $55.8bln to $53bln.  I could be off here, but I'm just trying to be roughly right.  Time will tell.

 

Yes, there are many second order effects not included.  One thing I learned from working at large financial institutions for decades is that no one knows, not even people on the inside.  The profit centers are complicated and diverse it's impossible to predict specifically where income/losses will come from.  I chose the bold path and ignored them all.

 

That said I will make one guess though.  One item looks promising, and that was not included in the above analysis. 

 

Ask anyone with know about what is going on at the large banks:  What is the biggest growth area of the bank in the last 5 years?

 

The answer is universal: Compliance (with Dodd-Frank)

 

The costs are crippling. So far, $36bln for the industry and BAC has no doubt forced to eat a healthy portion of that bitter fruit.  And these are the hard costs of systems, and salary for lawyers, accounting &  regulatory specialists. 

 

And, that is just the hard costs.  It does't include the soft costs that keep bankers/traders away from profitable business due to a fear of doing something that will trigger a government investigation.  This is what I refer to as the "wet blanket" effect.  It's not measurable but real.  And large.

 

Lifting away the Dodd-Frank burden on BAC and the industry will have a profoundly positive affect on the profitability of these banks.  I wouldn't be shocked to hear that Dodd-Frank related hard costs at BAC run in the $2bln-3bln.  And soft costs many be even higher.

 

I didn't include this into the above analysis, but I think the probability is pretty high that Dodd-Frank relief is on the way, and it will be very positive for earnings.

 

Probably not positive enough for you to wear a red hat, but definitely enough to keep you smiling!

 

Best,

 

Onyx

[CorpRaider]

Make my brokerage account great again.

[vinod1]

Gundlach: Trump victory sets stage for massive bond bear market

 

"Look for Trump to "amp up the deficit" to pay for infrastructure and other programs - producing an inflation rate of 3% and nominal GDP growth of 4-6%. Given that, there's no way the 10-year Treasury yield stays near its current level of 2.15%, and it could rise as high as 6% in the next four or five years."

 

 

What might this mean for BAC earnings and valuation?  Here is a back of the envelop estimate:

Q3 2016 run rate earning are $1.65/share

 

After 3 years of 5% GDP growth, $1.65/share grows to $1.82/share

 

At the end of Q3 2016, BAC declared a positive 100bp parallel yield curve shift would add $5.3 bln in PT earnings

 

Assuming BAC reduces curve exposure as rate rise, I'll assume the following:

 

1st 100bp = $5.3 bln

2nd 100bp = $4.0 bln

3rd 100bp = $3.0 bln

 

With a 300bp parallel move from here, the 10-year Treasury would be around 5.15% (it closed at 1.60% on 9/30), BAC would add $12.3 bln to PT earnings.

 

After tax (assuming 35% rate) $12.3*.65 = $8bln, or an additional EPS of $8/11= $0.73/share

 

$1.82 + $0.73 = $2.55/ share

 

I assume the planned & announced reduction in expenses will offset a likely increase in provisions necessary from higher growth.

 

With core earnings growing at 5% and reported earning growing at 15%, a reasonable multiple is 14x.

 

$2.55 x 14 = $35.70 /share in three years

 

And that doesn't even include the $1-$2 /share they have in existing DTA assets that will be converted into cash over this period.

 

I would love to have your scenario play out as a BAC investor. I might even put a Trump bumper sticker in that case. :) But I think you are ignoring 2nd order effects.

 

1. The spectacularly low interest rates have a corresponding parallel in spectacularly low loan loss rates. Provision for loan losses are running at about 0.4% level or about $3 billion. Normalized they are more likely to be in the $7 to $8 billion range. When interest rates increase we are also likely to have higher loan loss rates for various reasons. This is likely to knock off $4 to $5 billion from your estimates.

 

2. Interest rates going up by say 3% would reduce mortgage production income as there would be fewer people who would be taking out mortgages and mortgage refinancing would be close to shutdown. It would also depress housing prices significantly with its own negative consequences.

 

3. They would also incur losses on their securities portfolio during this period of rising rates. This is not going to hurt long term earnings power, but it would impact net income and book value during the transition period.

 

Overall, increases in interest rates (more accurately a steep yield curve) would be beneficial to the banks. just not as much as you extrapolate from company exposure to a 100 bps shift in interest rates.

 

Vinod

 

Vinod,  Thanks for the morning chuckle!

 

FWIW, the last I heard BAC give an indication of normalized provisions is $1.5bln per quarter but that was in 2013.  I assumed that number, and that the increase was offset by the planned expense reduction announced last quarter where non-interest expenses will drop almost $3bln from $55.8bln to $53bln.  I could be off here, but I'm just trying to be roughly right.  Time will tell.

 

Yes, there are many second order effects not included.  One thing I learned from working at large financial institutions for decades is that no one knows, not even people on the inside.  The profit centers are complicated and diverse it's impossible to predict specifically where income/losses will come from.  I chose the bold path and ignored them all.

 

That said I will make one guess though.  One item looks promising, and that was not included in the above analysis. 

 

Ask anyone with know about what is going on at the large banks:  What is the biggest growth area of the bank in the last 5 years?

 

The answer is universal: Compliance (with Dodd-Frank)

 

The costs are crippling. So far, $36bln for the industry and BAC has no doubt forced to eat a healthy portion of that bitter fruit.  And these are the hard costs of systems, and salary for lawyers, accounting &  regulatory specialists. 

 

And, that is just the hard costs.  It does't include the soft costs that keep bankers/traders away from profitable business due to a fear of doing something that will trigger a government investigation.  This is what I refer to as the "wet blanket" effect.  It's not measurable but real.  And large.

 

Lifting away the Dodd-Frank burden on BAC and the industry will have a profoundly positive affect on the profitability of these banks.  I wouldn't be shocked to hear that Dodd-Frank related hard costs at BAC run in the $2bln-3bln.  And soft costs many be even higher.

 

I didn't include this into the above analysis, but I think the probability is pretty high that Dodd-Frank relief is on the way, and it will be very positive for earnings.

 

Probably not positive enough for you to wear a red hat, but definitely enough to keep you smiling!

 

Best,

 

Onyx

 

I largely agree with you. I have a rather large allocation to financials in general besides BAC and my thoughts are largely in line with yours.

 

My guess of Dodd Frank costs are in the ~$1.5 billion range. This is scaling the costs compared to another much smaller but still SIFI bank that I worked with where I had heard some numbers thrown around (definitely not authoritative). But I would not be surprised if they are as high as you mention.

 

Vinod

[Rasputin]

To those who have not decreased their BAC exposure, what is your exposure as a % of portfolio?

 

I had more than 100% nominal exposure (LEAPS, Warrants & Stock) to BAC when it is at $7 and under. Reduced it about 5% range (stock only) at $17.

 

Increased to 25% to 30% of portfolio in the $12 range. Now reduced it to 5% range in high $18's.

 

Not trying to be a market timer, but it seems logical to increase or reduce allocation based on price/IV. I would think lots of board members would be doing the same, but it does not seem to be the case.

 

Vinod

 

I am at 90/7/1/2 - BAC/VRX/DVA/cash

 

I find it hard to find a business with as large moat as BAC trading at BAC multiple.  As long as management continue to be very mindful on the risks they're taking, and the multiple is not in the high teens, I will continue to hold it.  The shares have no expiration date so volatility like what we saw earlier this year means nothing to me other than opportunity to add more shares. 

 

As far as the negative impact of 300% parallel increase in interest rates, I'd say the impact will be less on BAC vs WFC or JPM.  BAC is still carrying large book of legacy asset with much higher chargeoff rate vs non legacy.  Contribution from mortgage banking income is lowest for BAC since they don't buy mortgages from broker and they continue to sell servicing portfolio serviced for others.  I believe their underwriting is most discipline vs WFC or JPM. Their willingness to forego current earnings for higher quality earnings will allow them to shine when tough times arrive. 

[onyx1]

To those who have not decreased their BAC exposure, what is your exposure as a % of portfolio?

 

I had more than 100% nominal exposure (LEAPS, Warrants & Stock) to BAC when it is at $7 and under. Reduced it about 5% range (stock only) at $17.

 

Increased to 25% to 30% of portfolio in the $12 range. Now reduced it to 5% range in high $18's.

 

Not trying to be a market timer, but it seems logical to increase or reduce allocation based on price/IV. I would think lots of board members would be doing the same, but it does not seem to be the case.

 

Vinod

 

BAC + WFC = 35%

 

All bought and held since 2011

[Jurgis]

@vinod1 and @Rasputin: you guys have balls.  8)

 

Now I understand how CoBF people have >30% returns per year.  ;)

 

Good luck

[rogermunibond]

The bank thesis has played out for the most unlikely of reasons though.  As much as any bank bull would like to think that "value" in and of itself is the catalyst, I would bet that no one, no one, thought that a demagogue populist being elected president in 2016 would be the precipitating factor in the big banks rerating.  Though maybe some did think that a Republican president would have featured into the 2016 or 2020 horizon.

 

In terms of process and outcome, I chalk up my gains on BAC to sheer luck.

[gurpaul88]

The bank thesis has played out for the most unlikely of reasons though.  As much as any bank bull would like to think that "value" in and of itself is the catalyst, I would bet that no one, no one, thought that a demagogue populist being elected president in 2016 would be the precipitating factor in the big banks rerating.  Though maybe some did think that a Republican president would have featured into the 2016 or 2020 horizon.

+1

[SlowAppreciation]

In terms of process and outcome, I chalk up my gains on BAC to sheer luck.

 

Luck favors the prepared!

[CorpRaider]

Buy it cheap and something good might happen.  Personally, I think things were already looking up (to a lesser degree) before Trump's win with the apparent realization by the central bankers that they needed to let the yield curve move up a little or they had no transmission mechanism for their policies.

[vinod1]

Even though BAC had been the single largest source of return for me over the last 5 years, valuation wise, I had been dead wrong.

 

My initial investment rested on a thesis of at least $1 EPS in a next to worst case scenario, $1.5 EPS in a conservative scenario and $2 EPS as most likely scenario by 2014. I thought buying at any price below $10 per share would provide above 15% returns.

 

If you ignore the last one week price increase, BAC was in the $16 range. So over 5 years, it went from $10 to $16 or about 10% annually. I am not sure but I think it might have under performed the stock market.

 

So as an investor my valuation and analysis was largely wide off the mark.

 

The only reason I ended up making good returns is due to the fact that BAC irrationally went to $5 in the meantime and subsequently wildly fluctuated gaining 50-60% and losing 30-40% many times.

 

A lot of the money was made from the fluctuations in price provided by market. So even though I made mistakes in valuation, I got bailed out by market.

 

There are a ton of other mistakes as well. Such as loading up on LEAPS which would have been a disaster if not for the fluctuations. 

 

Vinod

[vinod1]

@vinod1 and @Rasputin: you guys have balls.  8)

 

Now I understand how CoBF people have >30% returns per year.  ;)

 

Good luck

 

I think it is more a kind of psychological bias - familiarity and a bunch of others.

 

You know where people are less afraid to hold a large investment in the company they work for because it is familiar and seems less risky.

 

For me I worked at a SIFI bank for 13 years and spent heck of lot of time studying banking. So you can see how a lot of biases might be playing here. P&C and Banking are the two industries on which I spend most of my investment career on and surprise surprise I feel more comfortable concentrating a lot in this space.

 

Vinod

[benchmark]

The bank thesis has played out for the most unlikely of reasons though.  As much as any bank bull would like to think that "value" in and of itself is the catalyst, I would bet that no one, no one, thought that a demagogue populist being elected president in 2016 would be the precipitating factor in the big banks rerating.  Though maybe some did think that a Republican president would have featured into the 2016 or 2020 horizon.

 

In terms of process and outcome, I chalk up my gains on BAC to sheer luck.

 

I had tons of Jan 17 call options, unloaded them on Wednesday -- didn't think that Trump's election would generate this much excitement in banks :(

[KCLarkin]

As much as any bank bull would like to think that "value" in and of itself is the catalyst

 

Earlier this year, you were paying 10x earnings and less than tangible book value for a bank that is now less risky than most S&P 500 companies. So it was undeniably cheap.

 

BUT, you were also getting a free option on increased interest rates and future regulatory reforms.

 

In other words, BAC wasn't (excessively) cheap. But the embedded options were.

[berkshiremystery]

David Tepper's hedge fund buys new stakes in Apple, Bank of America and Facebook

 

I still assume there will be giant upward reevaluation in the next years,... BV, EPS, DPS, ROE. ;)

 

Cheers!

 

http://www.marketwatch.com/story/david-teppers-hedge-fund-buys-new-stakes-in-apple-bank-of-america-and-facebook-2016-11-14?siteid=yhoof2

 

[MYDemaray]

Becoming a bit of a story stock...you can sit tight and let the earnings build and probably earn a decent return on the warrants without any heroic multiple expansion assumptions. But the risk/reward has definitely shifted. For better or worse, I significantly pared my position today. Still have a little though. I have historically exited early on many investments though.

[rkbabang]

The bank thesis has played out for the most unlikely of reasons though.  As much as any bank bull would like to think that "value" in and of itself is the catalyst, I would bet that no one, no one, thought that a demagogue populist being elected president in 2016 would be the precipitating factor in the big banks rerating.  Though maybe some did think that a Republican president would have featured into the 2016 or 2020 horizon.

 

In terms of process and outcome, I chalk up my gains on BAC to sheer luck.

 

I had tons of Jan 17 call options, unloaded them on Wednesday -- didn't think that Trump's election would generate this much excitement in banks :(

 

I'm in the same boat.  I had no idea this would happen.  Luckily I still hold all of my A-Warrants. 

[Shane]

I held a 50/50 mix between common and warrants.  Sold out of my warrants recently at just shy of $6.60 (cost basis was $2.55) and have painfully watched them run in the meantime.  As the expiration date gets closer (although 2 years away still) I've had a harder time holding and took what I saw as an irrational market move (I had no idea what Trump would actually do once in office) to exit.  I consider this a pretty big mistake because the sell decision has less to do with IV and more to do with nerves.  Live and learn I suppose.  Glad to still own a decent slug of the common.

[LC]

I held a 50/50 mix between common and warrants.  Sold out of my warrants recently at just shy of $6.60 (cost basis was $2.55) and have painfully watched them run in the meantime.  As the expiration date gets closer (although 2 years away still) I've had a harder time holding and took what I saw as an irrational market move (I had no idea what Trump would actually do once in office) to exit.  I consider this a pretty big mistake because the sell decision has less to do with IV and more to do with nerves.  Live and learn I suppose.  Glad to still own a decent slug of the common.

 

Sold 1/3 of my common around $18.75. Wish I held on but grateful I didn't sell the other 2/3. I usually buy/sell in 1/3rds.

[racemize]

Still haven't trimmed (all common at this point).  Over 30% bank exposure, and it is getting difficult to keep holding.

[CorpRaider]

Do your braveheart impression in the mirror when you get up in the morning (if you feel you need).  HOOOOOLD,  HOOOOOOOLD.....

[benchmark]

Do your braveheart impression in the mirror when you get up in the morning (if you feel you need).  HOOOOOLD,  HOOOOOOOLD.....

 

Wish I had seen this earlier in the morning, caved and sold 1/4 of the remaining of what's left of my Jan 17 call.

[CorpRaider]

Someone wake me at $25.  ;D

[fareastwarriors]

Someone wake me at $25.  ;D

 

At this rate, it will be really soon!