BAC-WT - Bank of America Warrants

[sleepydragon]

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

[sleepydragon]

I just started stress testing banks one at a time, looking at their portfolios. I never really factored a scenario where there would be a nationwide stay at home policy. Still trying think this through.

 

I dont know how incentives would cause people to behave. Do people take advantage of this forbearance period to default on their loans? Would there be a nationwide one time exemption to any hit on people's credit ratings during this period?

 

Even if 25% of people do not make their loan payments for next 3 months and loan losses are only slightly elevated, one bank I am looking at would breakeven.

 

Modeling a 10% charge off rate on auto loans, 15% for credit cards and 5% for commercial loans for 2020, along with a 25% of people not making loan payments for 3 months, I get a hit of 25% to book value. I am assuming some cost cuts, marketing cuts, etc.

 

These numbers have no basis of course. Just thinking out loud on ways to stress test.

 

Vinod

 

There is a chance they we get European even Japan like zombie banks in the US. low NIM/ earnings power and assets that aren’t marked as defaulted, but aren’t paying either and just sit there on the balance sheet and fester. this whole loan forgiveness thing is OK, but I get a sense that it is  “Calvinball” time and default become a sport and in the end, banks will be the bag holder - because the buck stops somewhere.

 

Even if not, the low interest rate low NIM environment causes a semi permanent impairment that may justify the pounding these bank stocks have received.

 

I have gone through more than 200 hours of financial commission interviews when I started investing in banks in 2012.

 

https://cybercemetery.unt.edu/archive/fcic/20110310171826/http://fcic.gov/resource/interviews

 

The sense that I got was nearly every one of the powers that be in the Fed or various regulatory agencies is acutely aware of what happened to Japanese banks. They bring it up again and again and again. It is frankly shocking to hear about how much they are willing to do to help the banks. In all of their memoirs they write about this. They have the tools and enough leeway to do that. Right or wrong, the view is as goes the banks so goes the economy.

 

That is the reason, I would invest in US banks and do not touch any non-US bank, ever. You need to be comfortable with the regulatory regime to be able to invest in banks and I think in US that is going to continue to be favorable, regardless of whoever is in power.

 

NIM is going to be impacted but not as much as many seem to be worried about for the big banks. In addition, I have a partiality to card portfolios which are pretty resilient to NIM compression, at least relatively.

 

That said, yes many banks took a hit to their IV and need to have their IV's revised down. I think it is much less than 40% though.

 

Vinod

 

With regard to NIM, I got my jumbo mortgage from WFC in 2016, 30 yr 3.25%.

Today on WFC’s website, it’s 3.50...

 

[Cigarbutt]

I agree. But it looks like for now Americans are using those savings to pay down their credit cards. Totally not what I was expecting. Not in line with 10% charge offs on credit card portfolios either. I know it's still the early innings and it can change rather abruptly. But it's encouraging for now at least.

Listed below are some of the references used to formulate this post.

 

I would say this is nothing new, just perhaps an accentuation of a previous trend, although it looks like a reversal. Since the GFC, there has been a marked shift in credit card usage. Consumers have deleveraged. The absolute balance is back to where it was before but it's still way down once adjustments are made for population and GDP growth. There is potentially an obvious contributing factor: the compensatory (and more) growth in the balance of the 'consolidated' credit card. It's reasonable to expect a net down effect on the credit card balance when circumstances force people to pay down and when the 'consolidated' credit card account explodes to the upside as people, in the aggregate, are not always stupid (think of the permanent income stuff that Mr. Milton Friedman, of Nobel fame, talked about). I would submit that the consequences of the growth of the 'consolidated' credit card account are hard to handicap and are certainly not covered by present-day stress tests (for BAC and others).

 

https://wallethub.com/edu/cc/credit-card-debt/25533/

https://www.philadelphiafed.org/-/media/consumer-finance-institute/payment-cards-center/publications/discussion-papers/2016/dp16-01_what-happened-to-revolving-credit-card-balances-2009.pdf?la=en

The second link deals with the revolving component but is relevant nonetheless.

 

TL;DR version: If people continue to adapt their savings rate to the growth of the 'consolidated' credit card balance, they will eventually be able to spend more wisely but the interim period may be difficult for banks.

https://fred.stlouisfed.org/series/PSAVERT

 

Personal bias: I wonder if a beautiful deleveraging is possible.

[Viking]

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

My (conservative) vote is to get exposure through Berkshire for now (until more is known about virus’ impact on economy and big banks balance sheet). If a severe recession happens and the big banks sell off significantly from here perhaps shift to direct exposure.

 

After reporting big losses, the big US banks may come though this crisis in good shape with lots of tailwinds. As opposed to what happened in 2008.

 

1.) Accelerating concentration: the coming financial crisis will likely remove many smaller players. Some will go belly up. Lots will be gobbled up. The big will get bigger. The big boys are so well capitalized they will benefit from flight to quality.

2.) Accelerating shift to digitization: every customer will be learning to do all their banking from home in the coming months. The big boys will also continue to significantly outspend the smaller players so the quality gap (of digitized services) will also continue to widen.

3.) Weak Euro Competitors: continue to take market share from weak players who did not fix balance sheets in last crisis

 

One challenge: how to continue to shrink branch network and labour in highly political environment. Answer: very quietly. This could be especially problematic (politically) for WFC as they have lots of costs to take out (as they are now a couple of years behind BAC and JPM in reducing branches and unneeded staff).

 

One risk: higher taxes, especially if Democrat takes White House.

 

My guess is big banks (especially JPM and BAC) will be great investments as we come out of this recession.

[vinod1]

I agree. But it looks like for now Americans are using those savings to pay down their credit cards. Totally not what I was expecting. Not in line with 10% charge offs on credit card portfolios either. I know it's still the early innings and it can change rather abruptly. But it's encouraging for now at least.

 

 

Well, I guess what I am trying to say is that I am probably one of those people who is "paying down" my credit card.  Maybe my maximum balance during the month of January was, say, $2,000.  Now my maximum balance in April might be $500 (it might not even get that high because there is nothing to buy).  Since I pay off my cards religiously every month, would I not be included as a contributor to the aggregate pay-down?  If there are many people like me out there who religiously pay the balance at the end of every month, that might explain your drawdown.  The people who routinely run a balance from month-to-month and pay interest are probably not the ones who are responsible for the aggregate effect that you see.

 

 

SJ

 

SJ,

 

I might be wrong, but my understanding is what you are referring to is card balance what rb is referring to are loans. Only unpaid balances become loans.

 

The lower balance you are talking about should be reflected in lower payment volumes when banks start reporting.

 

Vinod

[vinod1]

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

My (conservative) vote is to get exposure through Berkshire for now (until more is known about virus’ impact on economy and big banks balance sheet). If a severe recession happens and the big banks sell off significantly from here perhaps shift to direct exposure.

 

After reporting big losses, the big US banks may come though this crisis in good shape with lots of tailwinds. As opposed to what happened in 2008.

 

1.) Accelerating concentration: the coming financial crisis will likely remove many smaller players. Some will go belly up. Lots will be gobbled up. The big will get bigger. The big boys are so well capitalized they will benefit from flight to quality.

2.) Accelerating shift to digitization: every customer will be learning to do all their banking from home in the coming months. The big boys will also continue to significantly outspend the smaller players so the quality gap (of digitized services) will also continue to widen.

3.) Weak Euro Competitors: continue to take market share from weak players who did not fix balance sheets in last crisis

 

One challenge: how to continue to shrink branch network and labour in highly political environment. Answer: very quietly. This could be especially problematic (politically) for WFC as they have lots of costs to take out (as they are now a couple of years behind BAC and JPM in reducing branches and unneeded staff).

 

One risk: higher taxes, especially if Democrat takes White House.

 

My guess is big banks (especially JPM and BAC) will be great investments as we come out of this recession.

 

Agree. We may have time to understand risks better, but I would not be too surprised if in a 2-3 day bloodbath banks open another 50% down. Would not have time to analyze or act at that time if we do not understand the tail risks.

 

Trying to get a better understanding of the tail risks. We can get a pretty good idea of consumers ability to pay back loans once we form a view on the economy. What is more difficult to figure out is consumer's willingness to pay.

 

Vinod

[vinod1]

I agree. But it looks like for now Americans are using those savings to pay down their credit cards. Totally not what I was expecting. Not in line with 10% charge offs on credit card portfolios either. I know it's still the early innings and it can change rather abruptly. But it's encouraging for now at least.

Listed below are some of the references used to formulate this post.

 

I would say this is nothing new, just perhaps an accentuation of a previous trend, although it looks like a reversal. Since the GFC, there has been a marked shift in credit card usage. Consumers have deleveraged. The absolute balance is back to where it was before but it's still way down once adjustments are made for population and GDP growth. There is potentially an obvious contributing factor: the compensatory (and more) growth in the balance of the 'consolidated' credit card. It's reasonable to expect a net down effect on the credit card balance when circumstances force people to pay down and when the 'consolidated' credit card account explodes to the upside as people, in the aggregate, are not always stupid (think of the permanent income stuff that Mr. Milton Friedman, of Nobel fame, talked about). I would submit that the consequences of the growth of the 'consolidated' credit card account are hard to handicap and are certainly not covered by present-day stress tests (for BAC and others).

 

https://wallethub.com/edu/cc/credit-card-debt/25533/

https://www.philadelphiafed.org/-/media/consumer-finance-institute/payment-cards-center/publications/discussion-papers/2016/dp16-01_what-happened-to-revolving-credit-card-balances-2009.pdf?la=en

The second link deals with the revolving component but is relevant nonetheless.

 

TL;DR version: If people continue to adapt their savings rate to the growth of the 'consolidated' credit card balance, they will eventually be able to spend more wisely but the interim period may be difficult for banks.

https://fred.stlouisfed.org/series/PSAVERT

 

Personal bias: I wonder if a beautiful deleveraging is possible.

 

Cigarbutt,

 

Thanks for the links.

 

I would think banks would be better off if consumers have a higher savings rate -> increase in deposits + lower charge offs. Maybe lower loan growth, but the other facts would be I think more significant. It is other industries that bear the cost of slower growth.

 

Vinod

[Cigarbutt]

Lately (like in 2019), BAC and other large banks have done well on the loan growth front with the underlying assumption that the consumer is "healthy" (financial point of view). However, from Fed data, loan growth (for example 2-yr % change) overall in banks in general (removing cyclical fluctuations) has been coming down in the last few years (in fact since WWII). Interestingly, since the early 80s, loan growth has slowed despite gradually lower interest rates and has been incredibly unimpressive despite very unconventional QE encouragement. 2-yr % change actually became negative around 2010 and, after an unconvincing spurt, is again slowing down (trend down already clear pre-virus), raising the possibility that increasing leverage at the aggregate level may involve longer term consequences that outsize short term gains. Loan growth in large banks since the GFC occurred mostly during the 'restructuring' phase and shadow banks have taken the relay, to some degree, and it's unclear (IMHO) how banks are free and clear of wholesale funding at this level. If into scenarios, i wouldn't worry too much about loan growth for now, i would try to assess how negative it could get and for how long.

In terms of savings rate, the aggregate numbers demonstrate a convincing rising trend but the savings are highly concentrated in the top 10% with the bottom 60% not doing any savings, questioning the financial health of the consumer overall, especially during a time of furloughs, deferrals and such. After WWII, public debt was very high and private debt was very low and perhaps this combination suggests that there is light at the end of the tunnel. However, private deleveraging has only started and entitlement spending as a % of GDP then was less than 2% then versus about 17% now.

Because of the virus new normal, I typically take a daily walk with my wife these days and along our typical itinerary and as part of a national theme, people have drawn rainbows in their windows frequently accompanied by a message that, translated, come to between "we'll be fine" and "this too shall pass" even if, on a viral level, the next fourteen days are shaping up to be unusually challenging.

 

[Rasputin]

From Jamie Dimon's 2020 annual letter

 

"Additionally, we have run an extremely adverse scenario that assumes an even deeper contraction of gross domestic product, down as much as 35% in the second quarter and lasting through the end of the year, and with U.S. unemployment continuing to increase, peaking at 14% in the fourth quarter. Even under this scenario, the company would still end the year with strong liquidity and a CET1 ratio of approximately 9.5% (common equity Tier 1 capital would still total $170 billion)."

 

That's a decline of roughly $18 B from Q4 2019 ($187.7 B CET1 on 12/31/2019). In 2019 DFAST, JPM CET1 (from start of stress period to minimum point) declined roughly double that of BAC's and WFC's.  I think my estimate of $30 B hit to BAC's CET1 in 2020 may be too conservative.

[Rasputin]

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

My (conservative) vote is to get exposure through Berkshire for now (until more is known about virus’ impact on economy and big banks balance sheet). If a severe recession happens and the big banks sell off significantly from here perhaps shift to direct exposure.

 

After reporting big losses, the big US banks may come though this crisis in good shape with lots of tailwinds. As opposed to what happened in 2008.

 

1.) Accelerating concentration: the coming financial crisis will likely remove many smaller players. Some will go belly up. Lots will be gobbled up. The big will get bigger. The big boys are so well capitalized they will benefit from flight to quality.

2.) Accelerating shift to digitization: every customer will be learning to do all their banking from home in the coming months. The big boys will also continue to significantly outspend the smaller players so the quality gap (of digitized services) will also continue to widen.

3.) Weak Euro Competitors: continue to take market share from weak players who did not fix balance sheets in last crisis

 

One challenge: how to continue to shrink branch network and labour in highly political environment. Answer: very quietly. This could be especially problematic (politically) for WFC as they have lots of costs to take out (as they are now a couple of years behind BAC and JPM in reducing branches and unneeded staff).

 

One risk: higher taxes, especially if Democrat takes White House.

 

My guess is big banks (especially JPM and BAC) will be great investments as we come out of this recession.

 

Agree. We may have time to understand risks better, but I would not be too surprised if in a 2-3 day bloodbath banks open another 50% down. Would not have time to analyze or act at that time if we do not understand the tail risks.

 

Trying to get a better understanding of the tail risks. We can get a pretty good idea of consumers ability to pay back loans once we form a view on the economy. What is more difficult to figure out is consumer's willingness to pay.

 

Vinod

 

I think the huge charge-offs in 2008/2009 is mostly due the customer's inability to make payments.  John Stumpf used to say "disease, divorce, death" are the 3 main reasons people don't pay outside of getting laid off.  This paycheck protection program, to me, is one of the most important tool that came out in the most recent $ 2 T package.  There was no PPP in 2008/2009 crisis.  While unemployment rate will be crazy bad, consumers' ability to keep their loans current won't be nearly as bad.  I believe people mostly want to keep their loan current, especially those who have managed to be in the >720 FICO score. 

[plato1976]

what's the possible size of hit (esp. to WFC) from the mortgage forbearance?

They don't even need ppl to show any evidence so really no idea how bad it will be .

Currently the jumbo loan market is in freeze  --- not a good sign

 

 

 

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

My (conservative) vote is to get exposure through Berkshire for now (until more is known about virus’ impact on economy and big banks balance sheet). If a severe recession happens and the big banks sell off significantly from here perhaps shift to direct exposure.

 

After reporting big losses, the big US banks may come though this crisis in good shape with lots of tailwinds. As opposed to what happened in 2008.

 

1.) Accelerating concentration: the coming financial crisis will likely remove many smaller players. Some will go belly up. Lots will be gobbled up. The big will get bigger. The big boys are so well capitalized they will benefit from flight to quality.

2.) Accelerating shift to digitization: every customer will be learning to do all their banking from home in the coming months. The big boys will also continue to significantly outspend the smaller players so the quality gap (of digitized services) will also continue to widen.

3.) Weak Euro Competitors: continue to take market share from weak players who did not fix balance sheets in last crisis

 

One challenge: how to continue to shrink branch network and labour in highly political environment. Answer: very quietly. This could be especially problematic (politically) for WFC as they have lots of costs to take out (as they are now a couple of years behind BAC and JPM in reducing branches and unneeded staff).

 

One risk: higher taxes, especially if Democrat takes White House.

 

My guess is big banks (especially JPM and BAC) will be great investments as we come out of this recession.

 

Agree. We may have time to understand risks better, but I would not be too surprised if in a 2-3 day bloodbath banks open another 50% down. Would not have time to analyze or act at that time if we do not understand the tail risks.

 

Trying to get a better understanding of the tail risks. We can get a pretty good idea of consumers ability to pay back loans once we form a view on the economy. What is more difficult to figure out is consumer's willingness to pay.

 

Vinod

 

I think the huge charge-offs in 2008/2009 is mostly due the customer's inability to make payments.  John Stumpf used to say "disease, divorce, death" are the 3 main reasons people don't pay outside of getting laid off.  This paycheck protection program, to me, is one of the most important tool that came out in the most recent $ 2 T package.  There was no PPP in 2008/2009 crisis.  While unemployment rate will be crazy bad, consumers' ability to keep their loans current won't be nearly as bad.  I believe people mostly want to keep their loan current, especially those who have managed to be in the >720 FICO score.

[Junto]

what's the possible size of hit (esp. to WFC) from the mortgage forbearance?

They don't even need ppl to show any evidence so really no idea how bad it will be .

Currently the jumbo loan market is in freeze  --- not a good sign

 

Forbearance doesn't in and of itself create losses. It's when the borrowers stop paying. With their homes on the line and their primary place of refuge during this difficult time, it is unlikely they will ultimately walk away. It is going to be quite a storm over the next several months but I think outsiders will be surprised at how well the banks work through this one versus the last one.

 

[Rasputin]

Forbearance does not equal default.  In fact loan status is frozen through out the forbearance period, i.e., if loan was current prior to forbearance it remains current during forbearance.

I would refer you to past DFAST results to see first lien, 2nd lien mortgage loss rates under those severely adverse scenarios for all the large banks. 

Frozen does not mean losses.  Jumbo is the best performing mortgage through out the 08/09 great recession.  Usually for higher net-worth, higher income, higher credit score, higher down payment, higher price/better location collateral.  All the GSIBs covet jumbo mortgages.  BAC also retain the jumbos they originate.  WFC is hitting the asset cap (I for one am grateful for it, I like WFC to have the highest capital, liquidity coverage ratio among the trillionaires during covid-19 depression) and jumbo private securitization is frozen so WFC have to wait for prepayment before they can originate more.  I don't mind it at all, I love they stop buying correspondent mortgages.  To me, WFC at $30 B under CET1 is a bargain. 

[vinod1]

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

My (conservative) vote is to get exposure through Berkshire for now (until more is known about virus’ impact on economy and big banks balance sheet). If a severe recession happens and the big banks sell off significantly from here perhaps shift to direct exposure.

 

After reporting big losses, the big US banks may come though this crisis in good shape with lots of tailwinds. As opposed to what happened in 2008.

 

1.) Accelerating concentration: the coming financial crisis will likely remove many smaller players. Some will go belly up. Lots will be gobbled up. The big will get bigger. The big boys are so well capitalized they will benefit from flight to quality.

2.) Accelerating shift to digitization: every customer will be learning to do all their banking from home in the coming months. The big boys will also continue to significantly outspend the smaller players so the quality gap (of digitized services) will also continue to widen.

3.) Weak Euro Competitors: continue to take market share from weak players who did not fix balance sheets in last crisis

 

One challenge: how to continue to shrink branch network and labour in highly political environment. Answer: very quietly. This could be especially problematic (politically) for WFC as they have lots of costs to take out (as they are now a couple of years behind BAC and JPM in reducing branches and unneeded staff).

 

One risk: higher taxes, especially if Democrat takes White House.

 

My guess is big banks (especially JPM and BAC) will be great investments as we come out of this recession.

 

Agree. We may have time to understand risks better, but I would not be too surprised if in a 2-3 day bloodbath banks open another 50% down. Would not have time to analyze or act at that time if we do not understand the tail risks.

 

Trying to get a better understanding of the tail risks. We can get a pretty good idea of consumers ability to pay back loans once we form a view on the economy. What is more difficult to figure out is consumer's willingness to pay.

 

Vinod

 

I think the huge charge-offs in 2008/2009 is mostly due the customer's inability to make payments.  John Stumpf used to say "disease, divorce, death" are the 3 main reasons people don't pay outside of getting laid off.  This paycheck protection program, to me, is one of the most important tool that came out in the most recent $ 2 T package.  There was no PPP in 2008/2009 crisis.  While unemployment rate will be crazy bad, consumers' ability to keep their loans current won't be nearly as bad.  I believe people mostly want to keep their loan current, especially those who have managed to be in the >720 FICO score.

 

I agree completely. This is pretty much my baseline view.

 

The main tail risk I can think of is if defaulting replaces suing as a national sport in US. There might be a lot of pressure to ignore defaults and for them not to be reported to the rating agencies during the covid-19 period. Something like that goes on for say 6-9 months, could cause a lot of pain to banks. This being an election year could set something like this in motion. Then banks would likely have to be bailed out again.

 

I know this is an extreme scenario, but I tend to like banks and have a tendency to make them into very large positions.

 

If I remember correctly, you take very large positions in banks as well. So just wanted to see if you have any thoughts on this?

 

Thanks

 

Vinod

 

 

[CorpRaider]

I can't really imagine administering this PPP program without the big banks there to do fraud screening/use their data/existing relationships with american business.  Same thing for the stimulus payments.

[matts]

I can't picture them disappearing either, but that doesn't mean they won't take huge losses. I agree with the post above. Incentives matter. And right now, there is no incentive for most people to pay their debt/rent/mortgage. The government programs for individuals have no requirements for what the money is used for and there is a moratorium on foreclosures.

Not sure why people are imagining a laid-off bartender who barely scraped by, gets a check from the government, and immediately pays his mortgage when all his buddies on Twitter are telling him "bro, you don't have to pay." at the very least he would consider hoarding the cash "just in case, see if things get worse"

Until this moral hazard is eliminated, I think the spike in delinquencies will be far above what most people think today. You can call it forbearance and not count it as delinquencies on your balance sheet, but at the end of the day, you are creating big misalignments in your asset/liability cash flows. The banks hedged out that mortgage based on a set payment schedule. Someone has to eat the risk of the mismatch and rehedging at prices different than when the asset was originally created.

[Rasputin]

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

My (conservative) vote is to get exposure through Berkshire for now (until more is known about virus’ impact on economy and big banks balance sheet). If a severe recession happens and the big banks sell off significantly from here perhaps shift to direct exposure.

 

After reporting big losses, the big US banks may come though this crisis in good shape with lots of tailwinds. As opposed to what happened in 2008.

 

1.) Accelerating concentration: the coming financial crisis will likely remove many smaller players. Some will go belly up. Lots will be gobbled up. The big will get bigger. The big boys are so well capitalized they will benefit from flight to quality.

2.) Accelerating shift to digitization: every customer will be learning to do all their banking from home in the coming months. The big boys will also continue to significantly outspend the smaller players so the quality gap (of digitized services) will also continue to widen.

3.) Weak Euro Competitors: continue to take market share from weak players who did not fix balance sheets in last crisis

 

One challenge: how to continue to shrink branch network and labour in highly political environment. Answer: very quietly. This could be especially problematic (politically) for WFC as they have lots of costs to take out (as they are now a couple of years behind BAC and JPM in reducing branches and unneeded staff).

 

One risk: higher taxes, especially if Democrat takes White House.

 

My guess is big banks (especially JPM and BAC) will be great investments as we come out of this recession.

 

Agree. We may have time to understand risks better, but I would not be too surprised if in a 2-3 day bloodbath banks open another 50% down. Would not have time to analyze or act at that time if we do not understand the tail risks.

 

Trying to get a better understanding of the tail risks. We can get a pretty good idea of consumers ability to pay back loans once we form a view on the economy. What is more difficult to figure out is consumer's willingness to pay.

 

Vinod

 

I think the huge charge-offs in 2008/2009 is mostly due the customer's inability to make payments.  John Stumpf used to say "disease, divorce, death" are the 3 main reasons people don't pay outside of getting laid off.  This paycheck protection program, to me, is one of the most important tool that came out in the most recent $ 2 T package.  There was no PPP in 2008/2009 crisis.  While unemployment rate will be crazy bad, consumers' ability to keep their loans current won't be nearly as bad.  I believe people mostly want to keep their loan current, especially those who have managed to be in the >720 FICO score.

 

I agree completely. This is pretty much my baseline view.

 

The main tail risk I can think of is if defaulting replaces suing as a national sport in US. There might be a lot of pressure to ignore defaults and for them not to be reported to the rating agencies during the covid-19 period. Something like that goes on for say 6-9 months, could cause a lot of pain to banks. This being an election year could set something like this in motion. Then banks would likely have to be bailed out again.

 

I know this is an extreme scenario, but I tend to like banks and have a tendency to make them into very large positions.

 

If I remember correctly, you take very large positions in banks as well. So just wanted to see if you have any thoughts on this?

 

Thanks

 

Vinod

 

https://www.bloomberg.com/news/articles/2020-04-03/mortgage-crisis-prompts-u-s-to-weigh-harder-line-with-borrowers

 

I think once this exceptional forbearance period is over and all the usual consequences for not being current on a loan are allowed to happen, people will go back to make an effort to be current on their loans.  I am comforted by the facts that those with the power to make these changes understand the need for a strong financial system and will not deliberately force banks to fail.  In a scenario where there will be no more foreclosures forever, no more default reporting on credit report forever, no more repossessing cars forever, WFC will be one of the last bank standing.  To me, though, this scenario is similar to a nuclear attack on multiple large cities in the US.  Yes, it's possible, but unlikely. 

[CorpRaider]

Yeah I agree with you that their integral nature to the system doesn't guarantee protection and adequate returns for the private capital enlisted to organize and maintain the banks.  But it's probably a pretty good bet imop (and has been for a couple hundred years). 

 

Sounds like we will get a lot more PPP to help shore up SMBs (and the banks via the risk free assets + fees).  Media reports indicate that the Democrats in Congress came out with a $250 billion stimulus part 4 wish list, which just happens to match the $250 billion in additional SBA loans/PPP Mnuchin tweeted about.

[Junto]

I can't really imagine administering this PPP program without the big banks there to do fraud screening/use their data/existing relationships with american business.  Same thing for the stimulus payments.

 

Not as difficult as you think. Community Banks like mine are knocking these out very well.

[vinod1]

TBTF bank investing is soooo 2012...

 

They all seem to have similar challenges. If you like banks why not just go with JPM or buy BRK for the exposure and management.

 

Why JPM and not BAC?

 

Just my opinion, but Jamie Dimon is on another level. A total man's man, a leader's leader. The gold standard. Hope he recovers from the heart surgery. Would be impossible to replace.

 

Agree with everything regarding Dimon but I think Moynihan is underrated because he lacks the charisma and aura, frankly he's kind of boring in his interviews. But I think a boring banker is a good thing. I think both men are great.

 

No point in arguing about this. Just buy the whole group, all the 4 banks :)

 

My (conservative) vote is to get exposure through Berkshire for now (until more is known about virus’ impact on economy and big banks balance sheet). If a severe recession happens and the big banks sell off significantly from here perhaps shift to direct exposure.

 

After reporting big losses, the big US banks may come though this crisis in good shape with lots of tailwinds. As opposed to what happened in 2008.

 

1.) Accelerating concentration: the coming financial crisis will likely remove many smaller players. Some will go belly up. Lots will be gobbled up. The big will get bigger. The big boys are so well capitalized they will benefit from flight to quality.

2.) Accelerating shift to digitization: every customer will be learning to do all their banking from home in the coming months. The big boys will also continue to significantly outspend the smaller players so the quality gap (of digitized services) will also continue to widen.

3.) Weak Euro Competitors: continue to take market share from weak players who did not fix balance sheets in last crisis

 

One challenge: how to continue to shrink branch network and labour in highly political environment. Answer: very quietly. This could be especially problematic (politically) for WFC as they have lots of costs to take out (as they are now a couple of years behind BAC and JPM in reducing branches and unneeded staff).

 

One risk: higher taxes, especially if Democrat takes White House.

 

My guess is big banks (especially JPM and BAC) will be great investments as we come out of this recession.

 

Agree. We may have time to understand risks better, but I would not be too surprised if in a 2-3 day bloodbath banks open another 50% down. Would not have time to analyze or act at that time if we do not understand the tail risks.

 

Trying to get a better understanding of the tail risks. We can get a pretty good idea of consumers ability to pay back loans once we form a view on the economy. What is more difficult to figure out is consumer's willingness to pay.

 

Vinod

 

I think the huge charge-offs in 2008/2009 is mostly due the customer's inability to make payments.  John Stumpf used to say "disease, divorce, death" are the 3 main reasons people don't pay outside of getting laid off.  This paycheck protection program, to me, is one of the most important tool that came out in the most recent $ 2 T package.  There was no PPP in 2008/2009 crisis.  While unemployment rate will be crazy bad, consumers' ability to keep their loans current won't be nearly as bad.  I believe people mostly want to keep their loan current, especially those who have managed to be in the >720 FICO score.

 

I agree completely. This is pretty much my baseline view.

 

The main tail risk I can think of is if defaulting replaces suing as a national sport in US. There might be a lot of pressure to ignore defaults and for them not to be reported to the rating agencies during the covid-19 period. Something like that goes on for say 6-9 months, could cause a lot of pain to banks. This being an election year could set something like this in motion. Then banks would likely have to be bailed out again.

 

I know this is an extreme scenario, but I tend to like banks and have a tendency to make them into very large positions.

 

If I remember correctly, you take very large positions in banks as well. So just wanted to see if you have any thoughts on this?

 

Thanks

 

Vinod

 

https://www.bloomberg.com/news/articles/2020-04-03/mortgage-crisis-prompts-u-s-to-weigh-harder-line-with-borrowers

 

I think once this exceptional forbearance period is over and all the usual consequences for not being current on a loan are allowed to happen, people will go back to make an effort to be current on their loans.  I am comforted by the facts that those with the power to make these changes understand the need for a strong financial system and will not deliberately force banks to fail.  In a scenario where there will be no more foreclosures forever, no more default reporting on credit report forever, no more repossessing cars forever, WFC will be one of the last bank standing.  To me, though, this scenario is similar to a nuclear attack on multiple large cities in the US.  Yes, it's possible, but unlikely.

 

Thinking it over some more I agree with you completely.

 

I think banks have a way out from defaults if people try to wipe out debts during the covid-19 period. They can just extend forbearance for a long time 6-12 months, if that is what it takes. It would remove any political pressure. If you are not being asked to pay a dime for 12 months, there cannot be any political pressure to forgive debts.

 

FYI - I have less of a concern with Bank of America, I am thinking of card and auto loan focused banks when I asking the above questions.

 

Thanks

 

Vinod

[HJ]

"I think banks have a way out from defaults if people try to wipe out debts during the covid-19 period. They can just extend forbearance for a long time 6-12 months, if that is what it takes. It would remove any political pressure. If you are not being asked to pay a dime for 12 months, there cannot be any political pressure to forgive debts.

 

FYI - I have less of a concern with Bank of America, I am thinking of card and auto loan focused banks when I asking the above questions.

"

 

One thing quite different between mortgage market and credit card / auto loan market is the issue of "servicing" and the presence of government agencies in the ultimate financing of mortgages vs. other consumer lending products.

 

In mortgage servicing, the servicer (which is often times also the loan originator) are required to advance principal and interest to the mortgage bond investors if underlying borrowers don't pay.  These advances are ultimately recovered with interest when either the borrower pays back delinquent P&I or the servicer sells the house and is paid back from liquidation proceeds.  The US government can mandate a forbearance, and stop foreclosure, but it's the servicers who end up advancing the P&I and be stuck with the bill. Because the agencies have such a dominant presence in the functioning of the US mortgage market, the US government also feels like they have a stick to enforce these servicing behavior.  For example, mortgage relief was mandated in the relief bill that was just signed.  In auto loans and credit cards, the government is much less involved to start with, so have much less ability or reason to regulate how those loans are serviced and collected. 

 

https://www.cnbc.com/2020/04/08/coronavirus-mortgage-industry-fires-back-at-regular-who-refuses-to-help-servicers.html

 

On the flip side, money is fungible from the consumer perspective.  During the financial crisis, there was evidence that a lot of people strategically defaulted on mortgage payments, but stayed current on auto loan payments, and some card payments.  In addition, car loans and credit card loans are priced for much more credit risk to start with.  It's not obvious whether the lenders / servicer will ultimately suffer more pain from card and auto lending or mortgages.

[plato1976]

Hi, Rasputin:

 

I think at this point, it's fair to say that a very long recession is quite likely. Just in my opinion that the current U.S. system is not well prepared to handle a pandemic. We still don't have enough testing capability yet, and the tracing mechanism is almost missing to keep the 2nd and 3rd wave when reopening happens. As far as I can see, China and a few Asia countries are doing a better work in tracing more specifically (in some cases sacrificing citizen privacy - maybe for good reasons). I just don't see how U.S. can contain this virus well down the road, and a gradual re-opening is unavoidable. So I do think we may be able to avoid a total collapse, but there will be off-on-off-on-off-on... down the road, and this whole process can drag out quite long until the vaccine is available and/or the virus dies down by itself, which on average takes 2-3 years. More specifically, in such an env, econ will be very weak (esp offline retailers/commercial real estate/airline/hospitality/energy etc. etc.), so it's not unreasonable to think the loan loss may be worse than the average case you assumed in the post weeks ago. I think this is the ultimate reason why banks are so weak now, esp WFC which has a big exposure to mortgages. I agree US big banks came into this recession with a much better balance sheet, but I just doubt it's strong enough to avoid severe equity impair in such an env which I am envisioning 

 

/Plato

 

I just started stress testing banks one at a time, looking at their portfolios. I never really factored a scenario where there would be a nationwide stay at home policy. Still trying think this through.

 

I dont know how incentives would cause people to behave. Do people take advantage of this forbearance period to default on their loans? Would there be a nationwide one time exemption to any hit on people's credit ratings during this period?

 

Even if 25% of people do not make their loan payments for next 3 months and loan losses are only slightly elevated, one bank I am looking at would breakeven.

 

Modeling a 10% charge off rate on auto loans, 15% for credit cards and 5% for commercial loans for 2020, along with a 25% of people not making loan payments for 3 months, I get a hit of 25% to book value. I am assuming some cost cuts, marketing cuts, etc.

 

These numbers have no basis of course. Just thinking out loud on ways to stress test.

 

Vinod

 

Hi Vinod,

 

Some things to consider:

 

1.  Regulatory guidance wrt Covid-19 related loan modification

 

https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20200322a1.pdf

 

2.  MBS prices have risen since year end so there should be positive OCI for BAC and WFC for Q1 2020

 

3.  I think most important input to CECL is their forecast on future unemployment rate and GDP growth/decline at 3/31/2020, so this could result in a huge provision charge for Q1 2020.  I don't know if they can assume that government paycheck protection program and other extraordinary measures will continue through the duration of stay-at-home order (the president signed the $2 Trillion package on 3/28/2020).

 

For now for BAC, I've estimated $39 B in NII (I used table 48, page 96 of the 10-K without offsetting higher rates they are getting from selling mbs to make new loans and volume of new loans) and $37 B in non NII (new loans should help with fees offset by reduction in investment banking income, interchange fees, etc)  along with $55 B in non interest expense (marketing and other cost cutting measures offset with bonus increases for front line workers, expenses incurred for workers from home, donations etc.).

 

I just use 100% of provisions shown in 2019 DFAST which was $48.3 B for BAC provision for credit losses in 2020.  I know current depression is much deeper than the lowest point in the stress test but the stress test covers 9 quarter of stress period with unemployment at 8.6% at the end of the 9 quarter stress period with no help from government response (such as the paycheck protection program) and banks changing their underwriting criteria etc.  2019 DFAST also assumed 25% in housing pricing index decline which has yet to happen.  I think while this covid-19 depression will result in much higher unemployment rate and much deeper gdp decline than the lowest point in the stress scenario, after 9 quarter (q2 2022) we will probably be back to 5-6% unemployment rate.  So I think this is a conservative estimate and we will likely see reserve releases in the future if they do indeed take $48.3 B in provision in Q1 2020. 

 

With that assumption, I get about $23.5 Billion in net losses to common shareholders, ignoring OCI, I estimate CET1 reduction of maybe $30 B including dividend payment between 12/31/2019 and 12/31/2020 for BAC.  I think BAC will easily make up this CET1 decline back in 2021-2022 especially with reserve releases as unemployment and gdp forecast get significantly better. 

 

While BAC is still trading at a slight premium to 12/31/2019 CET1, WFC is trading at $30 B discount to their 12/31/2019 CET1. 

 

I do hope this covid-19 depression will kill a bunch of fintechs, mortage servicers, other non bank competitors and the future hopefuls...die die die :)

 

Wrt Paycheck Protection Program

 

here is the SBA rule for lenders

 

https://www.sba.gov/sites/default/files/2020-04/PPP--IFRN%20FINAL_0.pdf

 

" Lenders must comply with the applicable lender obligations set forth in this interim final rule, but will be held harmless for borrowers’ failure to comply with program criteria; remedies for borrower violations or fraud are separately addressed in this interim final rule...The Administrator will hold harmless any lender that relies on such borrower documents and attestation from a borrower.  The Administrator, in consultation with the Secretary, has determined that lender reliance on a borrower’s required documents and attestation is

necessary and appropriate in light of section 1106(h) of the Act, which prohibits the Administrator from taking an enforcement action or imposing penalties if the lender has received a borrower attestation.  "

[Viking]

Will there not be an opportunity for the big US banks to earn their way through this? Their revenue base is pretty diversified. They do have the ability to reduce expenses; just not yet. Much of banking can be done electronically. As well, the Fed wants a healthy banking system so their will likely be help there. Yes, we likely will get a year or two of pretty weak results. As long as the current recession is only mild or medium in strength the banks should be ok investments.

 

Where this gets tough is if the current recession is severe and lasts for years (perhaps with mild deflation). If this recession really is the worst since the Great Depression then it is impossible to know what will happen to the banks and their earnings.

 

Right now, banks are in my too hard pile as i think there is a non-trivial chance we could see a severe recession. So i do not have any direct ownership. However, i do own BRK and am ok with their bank exposure. We will know much more in 6 months :-)

[undervalued]

I agree the US gradual re-opening is likely but I don't think the US will close it back up even after resurgence of cases. The US has never valued human life as much as it has today by closing the economy. When US figured it out that closing the economy has cost the country far more than letting people die, it won't do so again in the future.

 

Hi, Rasputin:

 

I think at this point, it's fair to say that a very long recession is quite likely. Just in my opinion that the current U.S. system is not well prepared to handle a pandemic. We still don't have enough testing capability yet, and the tracing mechanism is almost missing to keep the 2nd and 3rd wave when reopening happens. As far as I can see, China and a few Asia countries are doing a better work in tracing more specifically (in some cases sacrificing citizen privacy - maybe for good reasons). I just don't see how U.S. can contain this virus well down the road, and a gradual re-opening is unavoidable. So I do think we may be able to avoid a total collapse, but there will be off-on-off-on-off-on... down the road, and this whole process can drag out quite long until the vaccine is available and/or the virus dies down by itself, which on average takes 2-3 years. More specifically, in such an env, econ will be very weak (esp offline retailers/commercial real estate/airline/hospitality/energy etc. etc.), so it's not unreasonable to think the loan loss may be worse than the average case you assumed in the post weeks ago. I think this is the ultimate reason why banks are so weak now, esp WFC which has a big exposure to mortgages. I agree US big banks came into this recession with a much better balance sheet, but I just doubt it's strong enough to avoid severe equity impair in such an env which I am envisioning 

 

/Plato

 

I just started stress testing banks one at a time, looking at their portfolios. I never really factored a scenario where there would be a nationwide stay at home policy. Still trying think this through.

 

I dont know how incentives would cause people to behave. Do people take advantage of this forbearance period to default on their loans? Would there be a nationwide one time exemption to any hit on people's credit ratings during this period?

 

Even if 25% of people do not make their loan payments for next 3 months and loan losses are only slightly elevated, one bank I am looking at would breakeven.

 

Modeling a 10% charge off rate on auto loans, 15% for credit cards and 5% for commercial loans for 2020, along with a 25% of people not making loan payments for 3 months, I get a hit of 25% to book value. I am assuming some cost cuts, marketing cuts, etc.

 

These numbers have no basis of course. Just thinking out loud on ways to stress test.

 

Vinod

 

Hi Vinod,

 

Some things to consider:

 

1.  Regulatory guidance wrt Covid-19 related loan modification

 

https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20200322a1.pdf

 

2.  MBS prices have risen since year end so there should be positive OCI for BAC and WFC for Q1 2020

 

3.  I think most important input to CECL is their forecast on future unemployment rate and GDP growth/decline at 3/31/2020, so this could result in a huge provision charge for Q1 2020.  I don't know if they can assume that government paycheck protection program and other extraordinary measures will continue through the duration of stay-at-home order (the president signed the $2 Trillion package on 3/28/2020).

 

For now for BAC, I've estimated $39 B in NII (I used table 48, page 96 of the 10-K without offsetting higher rates they are getting from selling mbs to make new loans and volume of new loans) and $37 B in non NII (new loans should help with fees offset by reduction in investment banking income, interchange fees, etc)  along with $55 B in non interest expense (marketing and other cost cutting measures offset with bonus increases for front line workers, expenses incurred for workers from home, donations etc.).

 

I just use 100% of provisions shown in 2019 DFAST which was $48.3 B for BAC provision for credit losses in 2020.  I know current depression is much deeper than the lowest point in the stress test but the stress test covers 9 quarter of stress period with unemployment at 8.6% at the end of the 9 quarter stress period with no help from government response (such as the paycheck protection program) and banks changing their underwriting criteria etc.  2019 DFAST also assumed 25% in housing pricing index decline which has yet to happen.  I think while this covid-19 depression will result in much higher unemployment rate and much deeper gdp decline than the lowest point in the stress scenario, after 9 quarter (q2 2022) we will probably be back to 5-6% unemployment rate.  So I think this is a conservative estimate and we will likely see reserve releases in the future if they do indeed take $48.3 B in provision in Q1 2020. 

 

With that assumption, I get about $23.5 Billion in net losses to common shareholders, ignoring OCI, I estimate CET1 reduction of maybe $30 B including dividend payment between 12/31/2019 and 12/31/2020 for BAC.  I think BAC will easily make up this CET1 decline back in 2021-2022 especially with reserve releases as unemployment and gdp forecast get significantly better. 

 

While BAC is still trading at a slight premium to 12/31/2019 CET1, WFC is trading at $30 B discount to their 12/31/2019 CET1. 

 

I do hope this covid-19 depression will kill a bunch of fintechs, mortage servicers, other non bank competitors and the future hopefuls...die die die :)

 

Wrt Paycheck Protection Program

 

here is the SBA rule for lenders

 

https://www.sba.gov/sites/default/files/2020-04/PPP--IFRN%20FINAL_0.pdf

 

" Lenders must comply with the applicable lender obligations set forth in this interim final rule, but will be held harmless for borrowers’ failure to comply with program criteria; remedies for borrower violations or fraud are separately addressed in this interim final rule...The Administrator will hold harmless any lender that relies on such borrower documents and attestation from a borrower.  The Administrator, in consultation with the Secretary, has determined that lender reliance on a borrower’s required documents and attestation is

necessary and appropriate in light of section 1106(h) of the Act, which prohibits the Administrator from taking an enforcement action or imposing penalties if the lender has received a borrower attestation.  "

[Viking]

I agree the US gradual re-opening is likely but I don't think the US will close it back up even after resurgence of cases. The US has never valued human life as much as it has today by closing the economy. When US figured it out that closing the economy has cost the country far more than letting people die, it won't do so again in the future.

 

The US government will do what it needs to do moving forward. If we get a spike in cases at a business or in a region you can expect a targeted lock down in response (look at the meat packing plants). If governments do not respect the virus then we risk greater economic pain.

 

Look at China today. Or Taiwan. Or South Korea. Or Singapore. Economy is opening up very slowly with very stringent testing, contact tracing in place. And they still have lapses. They are still VERY afraid of the virus; they are not stupid.

 

The good news is it does look like warm, humid weather helps. Perhaps this will help the next 4 months.