BAC-WT - Bank of America Warrants

[twacowfca]

internally bac looked at things and said "things look good". however, they did not anticipate that externally, people were being hyper critical. all the stuff they are doing is for them. if you are in a beauty pageant, you don't wear what you like you wear what the judges will like.

 

Or what you think the judges will like.  The truth is that investors as a group are not dumb.  ( although they do exhibit herding behavior) Investors will usually give much weight to what they perceive is the future and ignore window dressing.

 

except they can be incredibly and massively wrong at inflection points. take a look at LCAPA in late 2008 for example of just how wrong they can be. that's one example.

 

Frightened herds may stampeed over a cliff.  A stampeed that winds up in a box canyon will mill around for awhile and then come back out of it.  :)

[sswan11]

S&P downgrades;  might be an interesting day tomorrow:

 

http://finance.yahoo.com/news/S-P-cuts-ratings-big-banks-reuters-2017198224.html?x=0

[meiroy]

S&P downgrades;  might be an interesting day tomorrow:

 

http://finance.yahoo.com/news/S-P-cuts-ratings-big-banks-reuters-2017198224.html?x=0

 

Following recent market movements it probably means a serious rally of the banks. Reason being is that they are all considered to be triple FFF while all of a sudden people see this A** thing and rejoice, things are much better than previously assumed. Or not.

 

On the other hand they upgraded two Chinese banks; what is their new method for ranking, NPL < 10% downgrade, NPL > 40% upgrade?

[moore_capital54]

If you look at the methodology it appears the biggest contributor to the downgrade for US banks was the sovereign exposure. S&P in their new methodology use the host nations Soveriegn Rating as the foundation and work their way up, and given the US was downgraded this is now reflected in the ratings of all US Banks.

[berkshiremystery]

Fed, Five Central Banks Cut Rate on Dollar Swaps

 

The interest rate has been reduced to the dollar overnight index swap rate plus 50 basis points, or half a percentage point, from 100 basis points, and the program was extended to Feb. 1, 2013, the Fed said in a statement in Washington. The Fed will coordinate with the European Central Bank in the program, which was also joined by the Bank of Canada, Bank of England, Bank of Japan (8301), and Swiss National Bank. (SNBN)

 

http://online.wsj.com/article/SB10001424052970204012004577069960192509068.html?mod=WSJ_hp_LEFTTopStories

 

http://www.bloomberg.com/news/2011-11-30/fed-five-central-banks-lower-interest-rate-on-dollar-swaps.html

[meiroy]

S&P downgrades;  might be an interesting day tomorrow:

 

http://finance.yahoo.com/news/S-P-cuts-ratings-big-banks-reuters-2017198224.html?x=0

 

Following recent market movements it probably means a serious rally of the banks.

 

First, for the record, it should be noticed how my un-ambiguous prediction manifested itself in yesterday's banks rally (/sarcasm) .

 

moore_capital54,

 

 

I understand your comment, thanks, but not why they upgraded the Chinese Banks all of a sudden. I'm sure it's absolutely impossible for S&P to analyze them. They did it based on what data? Probably 90% of the information related to the bank is filed under "state secrets" and would not be accessible to them. Do they reckon Chinese official statistics and numbers are dependable? Is there even any doubt that these banks have huge amounts of NPLs and would be NPLs hidden in their books somewhere? That would be just the edge of the ice-burg.

 

 

 

[racemize]

Hi all, I stumbled upon this message board a few days ago and have been reading everything in sight.  As a relatively new investor (value investing for just over a year now), this has been a breath of fresh air and I finally have a new favorite reading source over seeking alpha. 

 

Ignoring the pleasantries above, I've been trying to get a handle on BAC, whether it be warrants or common stock.  Other than the mortgage litigation issue and potential book value decreases (which I think I can get past given the current price), my main concern has been with respect to the very large CDS portfolio they picked up with the Merrill Lynch acquisition.  I'm sure everyone has read the crazy high gross notional CDS values for the 5 big banks (e.g., in the 244 trillion range) and I realize that net is much lower.  I also realize that the CDS exposure to European countries is lower than that amount and that a fair amount of those exposures are not necessarily directed to sovereign debt.  Regardless, with the possibility of European Crisis being large enough to consider, I worry about catastrophic failure (e.g., disorderly CDS resolution, similar to AIG/Lehman), particularly with respect to BAC.  In other words, even if the likelihood of BAC being a home run is 95%, I worry about the 5% chance of losing the capital. 

 

Moreover, the CDS market has been increasing since 2008, and I would like to have some reasons on how this CDS market is different than it was before, other than merely hoping that they have it better managed this time--I generally find hoping that someone has learned their lesson is not one to rely on.

 

I would be happy to hear your opinions on this, particularly those of you that are long BAC.

 

Disclosure: I'm long ~5% BAC right now.

[ubuy2wron]

Hi all, I stumbled upon this message board a few days ago and have been reading everything in sight.  As a relatively new investor (value investing for just over a year now), this has been a breath of fresh air and I finally have a new favorite reading source over seeking alpha. 

 

Ignoring the pleasantries above, I've been trying to get a handle on BAC, whether it be warrants or common stock.  Other than the mortgage litigation issue and potential book value decreases (which I think I can get past given the current price), my main concern has been with respect to the very large CDS portfolio they picked up with the Merrill Lynch acquisition.  I'm sure everyone has read the crazy high gross notional CDS values for the 5 big banks (e.g., in the 244 trillion range) and I realize that net is much lower.  I also realize that the CDS exposure to European countries is lower than that amount and that a fair amount of those exposures are not necessarily directed to sovereign debt.  Regardless, with the possibility of European Crisis being large enough to consider, I worry about catastrophic failure (e.g., disorderly CDS resolution, similar to AIG/Lehman), particularly with respect to BAC.  In other words, even if the likelihood of BAC being a home run is 95%, I worry about the 5% chance of losing the capital. 

 

Moreover, the CDS market has been increasing since 2008, and I would like to have some reasons on how this CDS market is different than it was before, other than merely hoping that they have it better managed this time--I generally find hoping that someone has learned their lesson is not one to rely on.

 

I would be happy to hear your opinions on this, particularly those of you that are long BAC.

 

Disclosure: I'm long ~5% BAC right now.

Of the 5 major U.S. banks with CDS exposure it appears that BAC has the lowest relative exposure to stated capital levels. BAC also is the only bank which has been very active in raising capital in the last 3 months. The mkt perceives this as a sign of weakness  as a long I perceive this as a sign of prudence. If a string of dominoes starts to fall the cost of capital raises will increase exponentialy. In both the banking and insurance business a fortress balance sheet is required to finish the race which is an never ending marathon.

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[alertmeipp]

I have made some reflections last few days, my take is JPM is better play. JPM have nice dividend and they should be able to increase divi and buy back more shares at discount soon.

 

BAC is at 6x next year earning, JPM is the same. You may argue BAC's normalized earning is 3-4 bucks while JPM won't 15-20 bucks.  But JPM's earning should enjoy higher multiple and BAC has higher risk to achieve normalized earning than JPM - i.e. equity offering, asset sales that work against long term profitability.

 

Having said that I have more BAC than JPM. I have problem buying the worst in the worst.. what I should be doing is buying the best at the worst sector.

[kevin4u2]

 

Ignoring the pleasantries above, I've been trying to get a handle on BAC, whether it be warrants or common stock.  Other than the mortgage litigation issue and potential book value decreases (which I think I can get past given the current price), my main concern has been with respect to the very large CDS portfolio they picked up with the Merrill Lynch acquisition.  I'm sure everyone has read the crazy high gross notional CDS values for the 5 big banks (e.g., in the 244 trillion range) and I realize that net is much lower.  I also realize that the CDS exposure to European countries is lower than that amount and that a fair amount of those exposures are not necessarily directed to sovereign debt.  Regardless, with the possibility of European Crisis being large enough to consider, I worry about catastrophic failure (e.g., disorderly CDS resolution, similar to AIG/Lehman), particularly with respect to BAC.  In other words, even if the likelihood of BAC being a home run is 95%, I worry about the 5% chance of losing the capital. 

 

Moreover, the CDS market has been increasing since 2008, and I would like to have some reasons on how this CDS market is different than it was before, other than merely hoping that they have it better managed this time--I generally find hoping that someone has learned their lesson is not one to rely on.

 

I would be happy to hear your opinions on this, particularly those of you that are long BAC.

 

 

Hi Racemize,

 

Can you please provide sources for your numbers?  For instance that the big 5 banks have CDS exposure of $244 trillion?  I think you might be confusing CDS exposure to total notional derivatives at the big 5 banks.  For instance BAC has $68.2 trillion in total notional derivatives outstanding.  What is interesting is 86% of these are interest rate contracts.  Specifically, looking at the CDS exposure, they have written about $2 trillion in CDS and have also purchased $2 trillion in CDS contracts.  Actual net exposure is about 100 billion CDS written and 100 billion CDS purchased.  At the end of the day netting CDS assets from liabilities gives an asset of $5.6 billion down from $6.6 billion and the beginning of the year. 

 

Now the real question is who/what are the CDS contracts written on AND who/what are the CDS contracts purchased on?  If you know I would like to know.  When people talk about banks being black boxes this is exactly what they mean (or should mean). 

 

Many say banks are black boxes because of the removal of mark to market (FASB 157), which is not true.  Mark to market still applies unless the market is illiquid or non existent.  For BAC Level 3 assets (the ones marked to fantasy) are 2.9% of total assets and 4.8% of risk weighted assets (RWA).  Ironically, these are the best among the large US banks, including WFC, JPM, C.  So when pundits toot their horn saying you can't believe the balance sheet, this is the part they are talking about.  This brings me to my next point. 

 

Many people claim that JPM has a rock solid balance sheet.  This includes newspapers and the nut jobs running around over at seeking alpha that either post OR comment out of ignorance.  Level 3 assets are 5.0% of total assets and 9.3% of risk weighted assets at JPM.  That is enough to drive a truck through.  They also have the largest notional amount of derivatives outstanding and the largest amount of trading assets.  If anyone says JPM has a rock solid balance sheet (including Jamie Dimon), are talking their own book or don't know the facts.  The only company with a rock solid balance sheet is Wells Fargo, the only one that didn't need tarp.   

 

Now I am long BAC.  The reason why I am long is because the numbers just say they are too cheap.  If they earned 1% on assets or 10% on equity that would be $22 billion profits vs a $55 billion market cap.  Even if the market cap doubled to $110 billion that stsill would only be 5 times average earnings.  The math isn't hard.  But i'll be honest; the reason why BAC is a crappy company is management.  How many screwups in the past year?  You can't even count them on all your fingers and all of your toes. 

 

Anyway getting back to the CDS stuff, it's not nearly as big as you think and if you have any details on who/what then that would be of value.  From what BAC has broke out on Europe in Q3 they have $1.5 billion in derivatives outstanding on Italian sovereign debt (likely CDS written) and have purchased $1.2 billion in CDS protection.  The net is about 300 million or not enough to worry about.  They also have some exposure Portugal and Spain in the tens of millions, but they are totally covered by CDS protection purchased. 

 

Just to put the European debt crisis in perspective, the US debt crisis was $15 trillion of bad mortgage loans against a $15 trillion dollar economy.  Huge.  If you add up all the sovereign debt of the PIIGS, it's $4 trillion at risk against a $15 trillion dollar economy (european union).  In my opinion, Italy and Spain won't default and they contribute $2.2 trillion and $0.9 trillion respectively to that $4 trillion total.  So the rough $1 trillion that's left isn't as much as the pundits make it out to be.  Now if the creditors accept a 50% haircut that further brings it down to $500 billion, something still very large but not unmanageable.  The real reason why Europe is a mess is because of the political structure and the inability to run a printing press to bail them out. 

 

Best Regards,

Kevin

 

canadianvalueinvesting.blogspot.com

[Grenville]

Here is a good thread on Derivative exposure at the big banks:

 

http://www.cornerofberkshireandfairfax.ca/forum/index.php?topic=5312" data-ipsquote-contentclass="forums_Topic" 57086#msg57086

 

My extra thoughts:

 

The netting of derivative exposure is a complicated thing. Ultimately it depends on the quality of the counter party. In addition, collateral is usually passed through in regards to most of the derivatives that helps mitigate the overall exposure. The worry would be in a extreme situation where the collateral isn't balanced or there is delay when the reference security defaults. (My worry is in this extreme situation given the interconnected system we have today.) It is clear that governments and central banks will stand behind these too big too fail institutions but politically someone has to lose whether that is equity holders, bond holders, or the tax payers. It is not entirely clear who that will be the next time we have a big stress at the too big too fail.

 

The other thing I look for is whether the derivatives are exchange traded or OTC (over the counter). The OTC stuff is not standardized and does not pass through a central clearing system that helps mitigate the counter party default risk. In addition, the exchange traded contracts have standardized terms regarding collateral and margin requirements. They are mostly all mark to market daily whereas the OTC depends on the contract. Exchange traded contracts are not devoid of risk because the member organizations must collectively support the clearing corporation if one of the counter parties defaults and the clearing corporation is exposed to loss.

 

Take all I say with a grain of salt and do your own research into all the issues. For me, the CDS exposures and lack of clarity on who counter parties are make it hard for me to invest in the equity of most of the big banks. If I could ignore the CDS exposure, then the banks are trading at cheap prices and I would go long bank equity. I will say I am long some of the banks through my exposure to Berkshire and Fairfax who own bank stocks and preferreds.

[racemize]

I have made some reflections last few days, my take is JPM is better play. JPM have nice dividend and they should be able to increase divi and buy back more shares at discount soon.

 

BAC is at 6x next year earning, JPM is the same. You may argue BAC's normalized earning is 3-4 bucks while JPM won't 15-20 bucks.  But JPM's earning should enjoy higher multiple and BAC has higher risk to achieve normalized earning than JPM - i.e. equity offering, asset sales that work against long term profitability.

 

Having said that I have more BAC than JPM. I have problem buying the worst in the worst.. what I should be doing is buying the best at the worst sector.

 

I'm mostly in WFC (I think ~20%) by the same logic (e.g., best in beaten down area), but have been looking at others with cheaper valuations/higher reward.  My concern with all of them is essentially this same CDS issue, particularly JPM which isn't as cheap as BAC (though I think it is in better shape overall).

[racemize]

 

Ignoring the pleasantries above, I've been trying to get a handle on BAC, whether it be warrants or common stock.  Other than the mortgage litigation issue and potential book value decreases (which I think I can get past given the current price), my main concern has been with respect to the very large CDS portfolio they picked up with the Merrill Lynch acquisition.  I'm sure everyone has read the crazy high gross notional CDS values for the 5 big banks (e.g., in the 244 trillion range) and I realize that net is much lower.  I also realize that the CDS exposure to European countries is lower than that amount and that a fair amount of those exposures are not necessarily directed to sovereign debt.  Regardless, with the possibility of European Crisis being large enough to consider, I worry about catastrophic failure (e.g., disorderly CDS resolution, similar to AIG/Lehman), particularly with respect to BAC.  In other words, even if the likelihood of BAC being a home run is 95%, I worry about the 5% chance of losing the capital. 

 

Moreover, the CDS market has been increasing since 2008, and I would like to have some reasons on how this CDS market is different than it was before, other than merely hoping that they have it better managed this time--I generally find hoping that someone has learned their lesson is not one to rely on.

 

I would be happy to hear your opinions on this, particularly those of you that are long BAC.

 

 

Hi Racemize,

 

Can you please provide sources for your numbers?  For instance that the big 5 banks have CDS exposure of $244 trillion?  I think you might be confusing CDS exposure to total notional derivatives at the big 5 banks.  For instance BAC has $68.2 trillion in total notional derivatives outstanding.  What is interesting is 86% of these are interest rate contracts.  Specifically, looking at the CDS exposure, they have written about $2 trillion in CDS and have also purchased $2 trillion in CDS contracts.  Actual net exposure is about 100 billion CDS written and 100 billion CDS purchased.  At the end of the day netting CDS assets from liabilities gives an asset of $5.6 billion down from $6.6 billion and the beginning of the year. 

 

Now the real question is who/what are the CDS contracts written on AND who/what are the CDS contracts purchased on?  If you know I would like to know.  When people talk about banks being black boxes this is exactly what they mean (or should mean). 

 

Many say banks are black boxes because of the removal of mark to market (FASB 157), which is not true.  Mark to market still applies unless the market is illiquid or non existent.  For BAC Level 3 assets (the ones marked to fantasy) are 2.9% of total assets and 4.8% of risk weighted assets (RWA).  Ironically, these are the best among the large US banks, including WFC, JPM, C.  So when pundits toot their horn saying you can't believe the balance sheet, this is the part they are talking about.  This brings me to my next point. 

 

Many people claim that JPM has a rock solid balance sheet.  This includes newspapers and the nut jobs running around over at seeking alpha that either post OR comment out of ignorance.  Level 3 assets are 5.0% of total assets and 9.3% of risk weighted assets at JPM.  That is enough to drive a truck through.  They also have the largest notional amount of derivatives outstanding and the largest amount of trading assets.  If anyone says JPM has a rock solid balance sheet (including Jamie Dimon), are talking their own book or don't know the facts.  The only company with a rock solid balance sheet is Wells Fargo, the only one that didn't need tarp.   

 

Now I am long BAC.  The reason why I am long is because the numbers just say they are too cheap.  If they earned 1% on assets or 10% on equity that would be $22 billion profits vs a $55 billion market cap.  Even if the market cap doubled to $110 billion that stsill would only be 5 times average earnings.  The math isn't hard.  But i'll be honest; the reason why BAC is a crappy company is management.  How many screwups in the past year?  You can't even count them on all your fingers and all of your toes. 

 

Anyway getting back to the CDS stuff, it's not nearly as big as you think and if you have any details on who/what then that would be of value.  From what BAC has broke out on Europe in Q3 they have $1.5 billion in derivatives outstanding on Italian sovereign debt (likely CDS written) and have purchased $1.2 billion in CDS protection.  The net is about 300 million or not enough to worry about.  They also have some exposure Portugal and Spain in the tens of millions, but they are totally covered by CDS protection purchased. 

 

Just to put the European debt crisis in perspective, the US debt crisis was $15 trillion of bad mortgage loans against a $15 trillion dollar economy.  Huge.  If you add up all the sovereign debt of the PIIGS, it's $4 trillion at risk against a $15 trillion dollar economy (european union).  In my opinion, Italy and Spain won't default and they contribute $2.2 trillion and $0.9 trillion respectively to that $4 trillion total.  So the rough $1 trillion that's left isn't as much as the pundits make it out to be.  Now if the creditors accept a 50% haircut that further brings it down to $500 billion, something still very large but not unmanageable.  The real reason why Europe is a mess is because of the political structure and the inability to run a printing press to bail them out. 

 

Best Regards,

Kevin

 

canadianvalueinvesting.blogspot.com

 

Thanks for your response Kevin, I did indeed misspeak above--I meant to write derivatives.  I had not caught on to the 86% being interest rate contracts, so that is fairly encouraging, but I also wonder if those contracts could be just as concerning in a default/disorderly default? 

 

Moreover, regarding the CDS contracts, I'm not too worried about the net amounts relative to the size of BAC, but I am worried about disorderly resolutions with defaulting parties, ala Lehmann, AIG.  I also agree with your assessment on the size of the debt issues relative to 2008, but weren't the CDS contracts the one's causing the number to increase even more, or was that part of the 15 trillion?  Also, if derivatives have increased since 2008, is it fair to assume that the CDS contracts on European debt could make that 4 trillion number even larger in terms of the finally result?

 

Other than that CDS concerns above, I'm totally on board and agree with your assessment on BAC's cheapness, I'm just worried about the low percentage catastrophic failure case.  Regarding management, I guess I've had a more positive view of Moynihan, other than the debit card fee fiasco--which mistakes are you referring to?

 

Thanks again for your detailed response.

[racemize]

Here is a good thread on Derivative exposure at the big banks:

 

http://www.cornerofberkshireandfairfax.ca/forum/index.php?topic=5312" data-ipsquote-contentclass="forums_Topic" 57086#msg57086

 

My extra thoughts:

 

The netting of derivative exposure is a complicated thing. Ultimately it depends on the quality of the counter party. In addition, collateral is usually passed through in regards to most of the derivatives that helps mitigate the overall exposure. The worry would be in a extreme situation where the collateral isn't balanced or there is delay when the reference security defaults. (My worry is in this extreme situation given the interconnected system we have today.) It is clear that governments and central banks will stand behind these too big too fail institutions but politically someone has to lose whether that is equity holders, bond holders, or the tax payers. It is not entirely clear who that will be the next time we have a big stress at the too big too fail.

 

The other thing I look for is whether the derivatives are exchange traded or OTC (over the counter). The OTC stuff is not standardized and does not pass through a central clearing system that helps mitigate the counter party default risk. In addition, the exchange traded contracts have standardized terms regarding collateral and margin requirements. They are mostly all mark to market daily whereas the OTC depends on the contract. Exchange traded contracts are not devoid of risk because the member organizations must collectively support the clearing corporation if one of the counter parties defaults and the clearing corporation is exposed to loss.

 

Take all I say with a grain of salt and do your own research into all the issues. For me, the CDS exposures and lack of clarity on who counter parties are make it hard for me to invest in the equity of most of the big banks. If I could ignore the CDS exposure, then the banks are trading at cheap prices and I would go long bank equity. I will say I am long some of the banks through my exposure to Berkshire and Fairfax who own bank stocks and preferreds.

 

Thanks Grenville.  I had read that thread and thought it was excellent, but came here to see what the BAC longs thought about it in terms of their investments.  I essentially agree with your conclusion above and was hoping that I was missing something.  However, I have been investing fairly heavily in WFC since their global derivative exposure is much less than the others (at least from my reading), which include investment banking sides.

[tombgrt]

You pay up for (some) certainty, especially when comparing with peers in a scary-looking sector with a lot of overall uncertainty. I don't think the difference in risk taken between BAC/C and WFC/JPM for example is correctly reflected by the market. Thus I have more BAC & C than I have WFC.

 

Take BAC. The uniqueness of it's situation (I'm referring to the large legal issues here of course), the fact that no one can really measure the ultimate destruction of value (again) and overall uncertainty, has completely driven off speculators, creating extremely low prices. There is no "air" in the stock, none. Because of this and the fear it creates, the chance that BAC's legal issues are underestimated by concensus is probably very small. Surprises happen when expectations are low, not the other way around.

 

The bear case doesn't add up and the potential reward is totally out of sync with risk taken imo. Especially for companies such as BAC because of the extra uncertainty but also for WFC, JPM, ...

[tombgrt]

 

 

Other than that CDS concerns above, I'm totally on board and agree with your assessment on BAC's cheapness, I'm just worried about the low percentage catastrophic failure case.  Regarding management, I guess I've had a more positive view of Moynihan, other than the debit card fee fiasco--which mistakes are you referring to?

 

 

I'm not Kevin (not by a long shot, but great post Kevin!) but maybe also:

 

- Overpromising on dividends;

- the $5b dilutive deal after he said BAC doesn't need extra capital from equity offering  (I don't see it as such, but the market did and it (could) damages reputation?);

- .. ?

 

He is very new to the CEO-game so those were probably rookie mistakes. He doesn't seem all that bad, maybe he'll grow into it more. Or not. I'm also interested in Kevin's view.  8)

[kevin4u2]

 

 

Other than that CDS concerns above, I'm totally on board and agree with your assessment on BAC's cheapness, I'm just worried about the low percentage catastrophic failure case.  Regarding management, I guess I've had a more positive view of Moynihan, other than the debit card fee fiasco--which mistakes are you referring to?

 

 

I'm not Kevin (not by a long shot, but great post Kevin!) but maybe also:

 

- Overpromising on dividends;

- the $5b dilutive deal after he said BAC doesn't need extra capital from equity offering  (I don't see it as such, but the market did and it (could) damages reputation?);

- .. ?

 

He is very new to the CEO-game so those were probably rookie mistakes. He doesn't seem all that bad, maybe he'll grow into it more. Or not. I'm also interested in Kevin's view.  8)

 

Hey guys,

 

You have hit on the big ones, especially regarding the dividend. That lost them a pile of credibility.  Other problems would be the dilutions after harping on the matter for months he then turns around and gives Buffett a sweet deal.  Then in Q3 report more dilution talk at bottom of page 10, 400 million shares or $3 billion in new debt to retire some preferreds.  I know the amount of shares isn't very significant and it may just end up being converted to debt, it's the principle of the matter.  You don't say one thing then consistently do the other.  Honesty and candor counts big, at least for me, and Brian is having trouble keeping his word. 

 

Some more stuff that bothers me is the interview he did with Berkowitz.  He said no bankrupcy for countrywide.  I have subsequently read that it was discussed at a board meeting in July/August.  Obviously that may not be true but the buck has to stop somewhere.  State your plans and keep them.  Don't be wishy washy, saying one thing in public and scheming the opposite in private. 

 

I fully understand that most of what is reported is likely garbage on BAC, so why doesn't come out hard against it.  Jamie Dimon definitely does.  At this point it really doesn't matter because nobody would believe him.  As Buffett has said, it takes years to develop a reputation and it can all be lost in a moment.  How can Brian M get the respect of the market, I don't know if it can be done. 

 

Regards,

Kevin

[ERICOPOLY]

Honesty and candor counts big, at least for me, and Brian is having trouble keeping his word. 

 

I'm not sure he ever said they wouldn't dilute.  I remember him saying that they could get to Basel III in time without needing to raise capital unless the economic outlook materially worsened.

 

A)  He could have been misleading on purpose by skillful choice of words

or

B)  Regulators might have pressured the bank to get their act together faster given the new worries about Europe and lower expectations for economic growth

 

It's not really lying if the situation changes.  My initial reaction was to not trust him anymore after the Buffett deal, but then that WSJ article about the regulators setting them straight over the summer helped me forgive him.

[ubuy2wron]

 

Ignoring the pleasantries above, I've been trying to get a handle on BAC, whether it be warrants or common stock.  Other than the mortgage litigation issue and potential book value decreases (which I think I can get past given the current price), my main concern has been with respect to the very large CDS portfolio they picked up with the Merrill Lynch acquisition.  I'm sure everyone has read the crazy high gross notional CDS values for the 5 big banks (e.g., in the 244 trillion range) and I realize that net is much lower.  I also realize that the CDS exposure to European countries is lower than that amount and that a fair amount of those exposures are not necessarily directed to sovereign debt.  Regardless, with the possibility of European Crisis being large enough to consider, I worry about catastrophic failure (e.g., disorderly CDS resolution, similar to AIG/Lehman), particularly with respect to BAC.  In other words, even if the likelihood of BAC being a home run is 95%, I worry about the 5% chance of losing the capital. 

 

Moreover, the CDS market has been increasing since 2008, and I would like to have some reasons on how this CDS market is different than it was before, other than merely hoping that they have it better managed this time--I generally find hoping that someone has learned their lesson is not one to rely on.

 

I would be happy to hear your opinions on this, particularly those of you that are long BAC.

 

 

Hi Racemize,

 

Can you please provide sources for your numbers?  For instance that the big 5 banks have CDS exposure of $244 trillion?  I think you might be confusing CDS exposure to total notional derivatives at the big 5 banks.  For instance BAC has $68.2 trillion in total notional derivatives outstanding.  What is interesting is 86% of these are interest rate contracts.  Specifically, looking at the CDS exposure, they have written about $2 trillion in CDS and have also purchased $2 trillion in CDS contracts.  Actual net exposure is about 100 billion CDS written and 100 billion CDS purchased.  At the end of the day netting CDS assets from liabilities gives an asset of $5.6 billion down from $6.6 billion and the beginning of the year. 

 

Now the real question is who/what are the CDS contracts written on AND who/what are the CDS contracts purchased on?  If you know I would like to know.  When people talk about banks being black boxes this is exactly what they mean (or should mean). 

 

Many say banks are black boxes because of the removal of mark to market (FASB 157), which is not true.  Mark to market still applies unless the market is illiquid or non existent.  For BAC Level 3 assets (the ones marked to fantasy) are 2.9% of total assets and 4.8% of risk weighted assets (RWA).  Ironically, these are the best among the large US banks, including WFC, JPM, C.  So when pundits toot their horn saying you can't believe the balance sheet, this is the part they are talking about.  This brings me to my next point. 

 

Many people claim that JPM has a rock solid balance sheet.  This includes newspapers and the nut jobs running around over at seeking alpha that either post OR comment out of ignorance.  Level 3 assets are 5.0% of total assets and 9.3% of risk weighted assets at JPM.  That is enough to drive a truck through.  They also have the largest notional amount of derivatives outstanding and the largest amount of trading assets.  If anyone says JPM has a rock solid balance sheet (including Jamie Dimon), are talking their own book or don't know the facts.  The only company with a rock solid balance sheet is Wells Fargo, the only one that didn't need tarp.   

 

Now I am long BAC.  The reason why I am long is because the numbers just say they are too cheap.  If they earned 1% on assets or 10% on equity that would be $22 billion profits vs a $55 billion market cap.  Even if the market cap doubled to $110 billion that stsill would only be 5 times average earnings.  The math isn't hard.  But i'll be honest; the reason why BAC is a crappy company is management.  How many screwups in the past year?  You can't even count them on all your fingers and all of your toes. 

 

Anyway getting back to the CDS stuff, it's not nearly as big as you think and if you have any details on who/what then that would be of value.  From what BAC has broke out on Europe in Q3 they have $1.5 billion in derivatives outstanding on Italian sovereign debt (likely CDS written) and have purchased $1.2 billion in CDS protection.  The net is about 300 million or not enough to worry about.  They also have some exposure Portugal and Spain in the tens of millions, but they are totally covered by CDS protection purchased. 

 

Just to put the European debt crisis in perspective, the US debt crisis was $15 trillion of bad mortgage loans against a $15 trillion dollar economy.  Huge.  If you add up all the sovereign debt of the PIIGS, it's $4 trillion at risk against a $15 trillion dollar economy (european union).  In my opinion, Italy and Spain won't default and they contribute $2.2 trillion and $0.9 trillion respectively to that $4 trillion total.  So the rough $1 trillion that's left isn't as much as the pundits make it out to be.  Now if the creditors accept a 50% haircut that further brings it down to $500 billion, something still very large but not unmanageable.  The real reason why Europe is a mess is because of the political structure and the inability to run a printing press to bail them out. 

 

Best Regards,

Kevin

 

canadianvalueinvesting.blogspot.com

GREAT POST KEVIN i AM REMINDED OF THE QUOTE WE HAVE NOTHING TO FEAR BUT FEAR ITSELF.

[Guest Hester]

 

Ignoring the pleasantries above, I've been trying to get a handle on BAC, whether it be warrants or common stock.  Other than the mortgage litigation issue and potential book value decreases (which I think I can get past given the current price), my main concern has been with respect to the very large CDS portfolio they picked up with the Merrill Lynch acquisition.  I'm sure everyone has read the crazy high gross notional CDS values for the 5 big banks (e.g., in the 244 trillion range) and I realize that net is much lower.  I also realize that the CDS exposure to European countries is lower than that amount and that a fair amount of those exposures are not necessarily directed to sovereign debt.  Regardless, with the possibility of European Crisis being large enough to consider, I worry about catastrophic failure (e.g., disorderly CDS resolution, similar to AIG/Lehman), particularly with respect to BAC.  In other words, even if the likelihood of BAC being a home run is 95%, I worry about the 5% chance of losing the capital. 

 

Moreover, the CDS market has been increasing since 2008, and I would like to have some reasons on how this CDS market is different than it was before, other than merely hoping that they have it better managed this time--I generally find hoping that someone has learned their lesson is not one to rely on.

 

I would be happy to hear your opinions on this, particularly those of you that are long BAC.

 

 

Hi Racemize,

 

Can you please provide sources for your numbers?  For instance that the big 5 banks have CDS exposure of $244 trillion?  I think you might be confusing CDS exposure to total notional derivatives at the big 5 banks.  For instance BAC has $68.2 trillion in total notional derivatives outstanding.  What is interesting is 86% of these are interest rate contracts.  Specifically, looking at the CDS exposure, they have written about $2 trillion in CDS and have also purchased $2 trillion in CDS contracts.  Actual net exposure is about 100 billion CDS written and 100 billion CDS purchased.  At the end of the day netting CDS assets from liabilities gives an asset of $5.6 billion down from $6.6 billion and the beginning of the year. 

 

Now the real question is who/what are the CDS contracts written on AND who/what are the CDS contracts purchased on?  If you know I would like to know.  When people talk about banks being black boxes this is exactly what they mean (or should mean). 

 

Many say banks are black boxes because of the removal of mark to market (FASB 157), which is not true.  Mark to market still applies unless the market is illiquid or non existent.  For BAC Level 3 assets (the ones marked to fantasy) are 2.9% of total assets and 4.8% of risk weighted assets (RWA).  Ironically, these are the best among the large US banks, including WFC, JPM, C.  So when pundits toot their horn saying you can't believe the balance sheet, this is the part they are talking about.  This brings me to my next point. 

 

Many people claim that JPM has a rock solid balance sheet.  This includes newspapers and the nut jobs running around over at seeking alpha that either post OR comment out of ignorance.  Level 3 assets are 5.0% of total assets and 9.3% of risk weighted assets at JPM.  That is enough to drive a truck through.  They also have the largest notional amount of derivatives outstanding and the largest amount of trading assets.  If anyone says JPM has a rock solid balance sheet (including Jamie Dimon), are talking their own book or don't know the facts.  The only company with a rock solid balance sheet is Wells Fargo, the only one that didn't need tarp.   

 

Now I am long BAC.  The reason why I am long is because the numbers just say they are too cheap.  If they earned 1% on assets or 10% on equity that would be $22 billion profits vs a $55 billion market cap.  Even if the market cap doubled to $110 billion that stsill would only be 5 times average earnings.  The math isn't hard.  But i'll be honest; the reason why BAC is a crappy company is management.  How many screwups in the past year?  You can't even count them on all your fingers and all of your toes. 

 

Anyway getting back to the CDS stuff, it's not nearly as big as you think and if you have any details on who/what then that would be of value.  From what BAC has broke out on Europe in Q3 they have $1.5 billion in derivatives outstanding on Italian sovereign debt (likely CDS written) and have purchased $1.2 billion in CDS protection.  The net is about 300 million or not enough to worry about.  They also have some exposure Portugal and Spain in the tens of millions, but they are totally covered by CDS protection purchased. 

 

Just to put the European debt crisis in perspective, the US debt crisis was $15 trillion of bad mortgage loans against a $15 trillion dollar economy.  Huge.  If you add up all the sovereign debt of the PIIGS, it's $4 trillion at risk against a $15 trillion dollar economy (european union).  In my opinion, Italy and Spain won't default and they contribute $2.2 trillion and $0.9 trillion respectively to that $4 trillion total.  So the rough $1 trillion that's left isn't as much as the pundits make it out to be.  Now if the creditors accept a 50% haircut that further brings it down to $500 billion, something still very large but not unmanageable.  The real reason why Europe is a mess is because of the political structure and the inability to run a printing press to bail them out. 

 

Best Regards,

Kevin

 

canadianvalueinvesting.blogspot.com

GREAT POST KEVIN i AM REMINDED OF THE QUOTE WE HAVE NOTHING TO FEAR BUT FEAR ITSELF.

 

SNAKES ARE PRETTY SCARY THOUGH.

[SharperDingaan]

Re Derivatives:

 

Keep in mind that derivatives artificially inflate values, & dissuade from real risk reduction. Your hedge against the adverse event is only as good as the collateral/credit of your counter-party (in practical terms, the collateral/credit of the global financial system), & if your counter-party goes down, the cumulative adverse impact of that failed hedge will hit you, & immediately. 

 

Example:

(1) Buy an asset at 100, & discover that it is worth only 20 were it liquidated today. You should liquidate, take the loss of 80, & move on. But you don’t ....

(2) Excellent hedge coy offers you a derivative that sets the asset value at 50, & promises to make good on any MTM < 50. They agree to post T-Bill collateral. You buy the hedge, value the position at 50, reduce the loss to 50 from 80 & get paid a bonus. The selling demand comes off the market & the market price rises accordingly. You are “bullet proof”, the market calms, but you still have asset.

(3) Global financial systems worsen, a counter-party goes down - & they take your counter-party with them. The global panic drives your assets value down to 10, you’re forced to liquidate, & suddenly you have a loss of 40 – on something that was supposedly “bullet proof”.  If you cannot cover that sudden loss of 40, you’re bankrupt.

 

SD

 

[Uccmal]

Good posts Kevin, raceMize. 

 

My take on the derivatves exposure at Bac was that it appears to net out.  Of course, one cannot know for sure due to counterparty risk.  The EU exposures not insured are very low. 

 

Regarding Moynihans perceived mistakes, I can forgive him for promising a dividend last year and not delivering.  Left up to himself, he would have honoured it.  He was told no by the regulators, after he had made that statement and has indicated he regretted the whole thing and would be very careful in the future.

 

He said he didn't need equity, then Buffett calls.  What would you do?  Do you think Warren would call back?  That was a one shot vote of confidence.  One does not turn that down.  Didn't need, and didn't want more capital are two different things. 

 

Converting preferreds to common is not Dilution.  It is designed to get them to Basel 3 faster. 

 

I can allow him some mistakes along the way when most actions are correct, and credible. 

 

Risk relative to price.  Each of the majors are probably on par in this regard, to where they are trading at.  My positions sizes in WFC, BAC, and JPM are about the same right now. 

[ShahKhezri]

Equity Residential, a Chicago-based real-estate investment trust, on Friday agreed to buy half of Barclays and Bank of America's stake for $1.33 billion, valuing Archstone around $16 billion, including about $11 billion in debt.

 

http://online.wsj.com/article/SB10001424052970204083204577078751820986334.html

 

[MrB]

Racemize,

Kyle Bass likes to ask his audiences, how many people think Greece will default. Most hands tend to go up. He then asks them a very specific question like what is Greece's outstanding debt or what is Greece's annual interest payments. Usually nobody has the answer.

 

The same seems to be true for derivatives. Few people bother to look at the facts. Very few people tend to read the Comptroller of the Currency's report, so get ahead of 99% of people that opine on derivatives.

 

So derivatives must read: http://www.occ.gov/topics/capital-markets/financial-markets/trading/derivatives/dq211.pdf

When reading don't confuse your billions and trillions.

Note Table 1

 

I don't buy into the benefits of netting, because 96% of derivatives are "held" by 5 banks and the problem is potentially bigger than the 5 of them.

 

Also, how will netting actually work? Legally it will be a nightmare http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1811164_code524668.pdf?abstractid=1476478&mirid=1 The paper is a bit of a slog, but worth the read.

 

Forgive me for doing this, but read pages 7-10 of this http://www.baobabglobalfund.com/Files/2010.pdf

 

In case it sounds like I am pontificating; I have spent many years looking at this issue and my conclusion is; "I know I don't know"

 

 

 

 

 

[Uccmal]

Thanks for that MrB, i agree with your tag line.  I guess it boils down to ones comfort level with not knowing. 

 

If I look across a cross section of businesses I hold or have held there are plenty of things I dont know about each of them. 

 

Take a really simple business such as FBK Pulp.  I cant know future pulp prices, future wood chip prices, the sudden 50% dilution of shares that occurred, whether management may suddenly try to do an acquisition of a couple of crappy prices, or whether a couple of major shareholders decided to take a bath to get rid of their shares.

 

Arguably there are more knowables with a major bank than many other businesses due to high visibility of their operations.  We know they have x number of storefronts that generate ongoing business, that investment banking is alive, what they are lending and to whom, risk character of management, etc. 

 

So, it becomes up to me to assess the risks of total loss versus gain and take or not take a position accordingly.  Most investments including major banks I would not invest greater than5-10% of my total assets.  Occassionally there are businesses where I feel comfortable enough to go higher.  The big Us banks Are not among them.  Due to the liquid availability of Leaps I can take a flier on the future success of these entities and limit my downside loss.