BAC-WT - Bank of America Warrants

[xazp]

I've got some comments on the R&W stuff. 

 

1)  BAC noted today that the Synorca settlement was already fully reserved a while ago (i.e. not this quarter).  The foreclosure settlement was also reserved by the time the settlement happened.  The recent credit card settlement, also already reserved.  Loan loss reserves - too high by at least ten billion.  Today, BAC says directly they've already reserved for the new private mortgages and everyone chooses not to believe them.  I don't get it. 

 

2)  In the past, I did some work on the payouts as a function of outstanding bonds.  The two bracketing numbers are roughly 7% and 30% of the value they put on the slides.

- the countrywide settlement.  $8.5Bn on ~$120Bn outstanding = 7%  <-- private bondholders have a difficult path to putbacks.

- GSE settlements.  They average out to about 30% of claims. 

 

3)  If you invert their reserves of $13Bn, you'd expect claims of somewhere between $45Bn and $185Bn (i.e. multipled by .07 through .30 to get back to their reserves). 

 

-- in past quarters, for example, the reserves have exceeded the claims.  So plainly BAC was expecting more to come into the "claims" bucket (unless they were anticipating paying more than they were asked to pay). 

 

4)  There are about $8Bn of GSE claims that BAC disagrees on.  These are claims that made over 25 payments, and BAC believes they did not warranty for mortgages that were paying customers for 2 or more years.  If BAC loses this disagreement, I'd expect about their historical loss rate (30%) on this, or $2.4Bn incremental to what they have reserved.  I believe in my presentation I put the downside case at $2.5Bn for the GSEs, (and around $10Bn if you sum up all the other loose ends) and I'm still OK with that number. 

 

 

 

 

 

 

 

[Parsad]

Hi Sanjeev,

 

Do you still think it'll trade at tangible book by Christmas?

 

Thanks

 

It'll depend on pressure from other parts of the world, but I don't see why not.  If you look at the business and where it is today compared to 3 years ago, and even some of its peers, there is no reason why it should not trade near tangible book.  They are extremely well capitalized for a bank that was on the brink three years ago.  They are running litigation and loans off the book.  They are cutting costs and focusing on core lines of business...primarily in the U.S.  They are doing everything right!  It's just a matter of time before the pig works its way through the python.  Cheers!

[Parsad]

I was really happy with today's earnings results.  The key number here is the 8.1% B3 ratio.  A year ago, the street said that BAC didn't have enough capital, and their capital levels were the worst of all the big banks.  Today, they have gone from last place to first - their capital levels are slightly above all the other big U.S. banks.  [C - 7.9%, JPM - 7.9%, WFC - 7.8%].  At this rate, they well might hit their final B3 target of 9% this year. 

 

To put that in context, my expectation was they'd take until mid-2013 to hit their current B3 ratio, and mid-2014 to hit their final levels.  So relative to my expectations, the wait time until buybacks just got shorter by a year or a year and half... wow.

 

They are currently earning at a pace of about $10Bn/year (today's earnings number was $2.5Bn), which creates about $15Bn/year in capital due to DTAs.  According to their investor presentation, they anticipate giving back most of the capital they generate to shareholders.  This seems to imply very high levels of shareholder buybacks. 

 

To me the very best outcome for a long-term shareholder is low price + large buybacks.  I mean, I want them to buy as many shares as they possibly can at current prices.  I will happily wait years and years if they can keep buying stock at these prices.

 

I couldn't agree more xazp!  I was very pleased with the quarterly report, and I think quarter over quarter, we should continue to see improvement.  The longer the price stays low, the more likely they will be able to buyback large amounts of shares in 1st and 2nd Q 2013...as a stock buyback program is a forgone conclusion now.  I would expect them to blow through the 9% Basel III hurdle by year-end, and they should get approval for a buyback and/or increased dividend.  They have a number of assets they still have to monetize, including about two-thirds of their real estate portfolio which has not been monetized through sale-leasebacks.  U.S. banks are in general, incredibly well-capitalized, and BAC has rapidly solidified their balance sheet.  Cheers! 

[xazp]

I couldn't agree more xazp!  I was very pleased with the quarterly report, and I think quarter over quarter, we should continue to see improvement.  The longer the price stays low, the more likely they will be able to buyback large amounts of shares in 1st and 2nd Q 2013...as a stock buyback program is a forgone conclusion now.  I would expect them to blow through the 9% Basel III hurdle by year-end, and they should get approval for a buyback and/or increased dividend.  They have a number of assets they still have to monetize, including about two-thirds of their real estate portfolio which has not been monetized through sale-leasebacks.  U.S. banks are in general, incredibly well-capitalized, and BAC has rapidly solidified their balance sheet.  Cheers!

 

Thanks Prasad, I was beginning to think I was the only one who viewed it that way!

 

I was just running through some numbers, and I think they might hit 9% level next quarter.  The reason that is important is the CCAR is based on Q3 numbers, so having met the final B3 level, they might get to return extra capital.  I think, unlike other companies, BAC has decided to shrink - and I think that will pay off to us as increased returns of capital. 

 

B3T1 (now) - 8.1%

Average B1T1 quarterly increase - .75%

B3T1 "bonus" over B1T1 - due to DTA usage - .35

B3T1 (Q3) - 9.2%

 

Looking at their supplemental info, their B1 capital increased by about $20bn in the last year.  B3 capital should have increased by even more - maybe $30Bn.  I don't know if that is sustainable (sounds high doesn't it?) but that kinda implies they could return $20Bn in capital (i.e. 25%) each year and still be growing their Basel 3 buffer. 

 

 

[Rabbitisrich]

For whatever reason, I didn't source this properly, but I have a note saying that BAC intends to reduce its long term debt to $220-$270 by the end of 2013. Did Moynihan lay out his debt reduction strategy to this extent?

 

 

The Basel III target is 9.5%, no? Are you guys (Xazp and Parsad) forecasting a sub-max SIFI buffer due to BAC's shrinkage?

[wescobrk]

Is anyone concerned about their Pre-tax pre provision of $5 billion? JPM and Wells is almost 75% higher.  That'll improve as non interest expense shrinks but that number is certainly concerning.

 

[xazp]

For whatever reason, I didn't source this properly, but I have a note saying that BAC intends to reduce its long term debt to $220-$270 by the end of 2013. Did Moynihan lay out his debt reduction strategy to this extent?

 

 

The Basel III target is 9.5%, no? Are you guys (Xazp and Parsad) forecasting a sub-max SIFI buffer due to BAC's shrinkage?

 

Debt reduction is mostly just maturing debt (i.e. TLGP debt) with some debt tenders built in.  They plan to issue no additional debt in 2012. 

 

The preliminary B3 target for BAC is 9%, for C and JPM 9.5%.  e.g. http://www.docstoc.com/docs/121176162/Credit-Suisse---Estimating-Global-SIFI-Buffers

 

I read the same on some leaked Basel 3 preliminary document. 

 

 

 

[Parsad]

Is anyone concerned about their Pre-tax pre provision of $5 billion? JPM and Wells is almost 75% higher.  That'll improve as non interest expense shrinks but that number is certainly concerning.

 

It's hard to figure what the correct number should be, unless you know the underwriting of the loans involved.  It's like Fairfax when they were running off their recoverables.  We don't know exactly what is provisioned, and what the underlying risk is.  Only time will tell if they provisioned correctly. 

 

Remember, they hired so many people to help with the loans, and as they runoff this business off their books, they will reduce the overhead.  Combine that with the existing plan in expense reduction, their pretty robust cash flows, and they have probably provisioned pretty good.  Excess?  Probably not.  Again, only time will tell, and they have the best idea what their loan portfolio is like.  Cheers!

[Rabbitisrich]

 

The preliminary B3 target for BAC is 9%, for C and JPM 9.5%.  e.g. http://www.docstoc.com/docs/121176162/Credit-Suisse---Estimating-Global-SIFI-Buffers

 

I read the same on some leaked Basel 3 preliminary document.

 

Very interesting, thank you. Kind of odd that the analyst uses 2009 figures, though.

[Uccmal]

No one who has invested in BAC at these price levels has made a mistake.  I dont believe its a value trap.  It is just taking alot of patience waiting for the major instituitions to come in and bid the stock up.  Management is taking the correct steps in the correct order to create a profit machine.

 

I have held BAC in some form or other for 2 years now.  Prior to the 2015 calls coming available I have shifted my focus to the "A" warrants.  I have dropped my 2013 exposure to 40'calls at 7.50, and hope to exit that before conversion at a profit.  I maintain around 650 2014 calls for now.  The US could enter a mild recesssion and be out of it before they expire. 

 

I expect Moynihan will ask for dividends and buybacks in a few months and cannot be denied if they have met all their capital Buffers. 

[xazp]

It's hard to figure what the correct number should be, unless you know the underwriting of the loans involved.  It's like Fairfax when they were running off their recoverables.  We don't know exactly what is provisioned, and what the underlying risk is.  Only time will tell if they provisioned correctly. 

 

Remember, they hired so many people to help with the loans, and as they runoff this business off their books, they will reduce the overhead.  Combine that with the existing plan in expense reduction, their pretty robust cash flows, and they have probably provisioned pretty good.  Excess?  Probably not.  Again, only time will tell, and they have the best idea what their loan portfolio is like.  Cheers!

 

BAC last year said that "normalized" PPNR would be $45Bn.  I don't know if that's still their guidance.  But the way they get there:

$150Bn in credit cards @ 10% spread = $15Bn PPNR

$800Bn in other loans @ 3.75% spread = $30Bn PPNR

and I guess the fees offset the non-interest expense. 

They say this implies $35Bn in pre-tax earnings. 

 

Anyone want to comment on their sample numbers?  I don't know if they are realistic or not. 

 

 

[onyx1]

I couldn't agree more xazp!  I was very pleased with the quarterly report, and I think quarter over quarter, we should continue to see improvement.  The longer the price stays low, the more likely they will be able to buyback large amounts of shares in 1st and 2nd Q 2013...as a stock buyback program is a forgone conclusion now.  I would expect them to blow through the 9% Basel III hurdle by year-end, and they should get approval for a buyback and/or increased dividend.  They have a number of assets they still have to monetize, including about two-thirds of their real estate portfolio which has not been monetized through sale-leasebacks.  U.S. banks are in general, incredibly well-capitalized, and BAC has rapidly solidified their balance sheet.  Cheers!

 

Thanks Prasad, I was beginning to think I was the only one who viewed it that way!

 

I was just running through some numbers, and I think they might hit 9% level next quarter.  The reason that is important is the CCAR is based on Q3 numbers, so having met the final B3 level, they might get to return extra capital.  I think, unlike other companies, BAC has decided to shrink - and I think that will pay off to us as increased returns of capital. 

 

B3T1 (now) - 8.1%

Average B1T1 quarterly increase - .75%

B3T1 "bonus" over B1T1 - due to DTA usage - .35

B3T1 (Q3) - 9.2%

 

Looking at their supplemental info, their B1 capital increased by about $20bn in the last year.  B3 capital should have increased by even more - maybe $30Bn.  I don't know if that is sustainable (sounds high doesn't it?) but that kinda implies they could return $20Bn in capital (i.e. 25%) each year and still be growing their Basel 3 buffer.

 

Can you explain your thinking on DTA treatment?  My understanding is that DTA's are generally not counted as capital under the proposed B3 rules, so that (all else equal) capital ratios will be lower than B1.

[racemize]

I couldn't agree more xazp!  I was very pleased with the quarterly report, and I think quarter over quarter, we should continue to see improvement.  The longer the price stays low, the more likely they will be able to buyback large amounts of shares in 1st and 2nd Q 2013...as a stock buyback program is a forgone conclusion now.  I would expect them to blow through the 9% Basel III hurdle by year-end, and they should get approval for a buyback and/or increased dividend.  They have a number of assets they still have to monetize, including about two-thirds of their real estate portfolio which has not been monetized through sale-leasebacks.  U.S. banks are in general, incredibly well-capitalized, and BAC has rapidly solidified their balance sheet.  Cheers!

 

Thanks Prasad, I was beginning to think I was the only one who viewed it that way!

 

I was just running through some numbers, and I think they might hit 9% level next quarter.  The reason that is important is the CCAR is based on Q3 numbers, so having met the final B3 level, they might get to return extra capital.  I think, unlike other companies, BAC has decided to shrink - and I think that will pay off to us as increased returns of capital. 

 

B3T1 (now) - 8.1%

Average B1T1 quarterly increase - .75%

B3T1 "bonus" over B1T1 - due to DTA usage - .35

B3T1 (Q3) - 9.2%

 

Looking at their supplemental info, their B1 capital increased by about $20bn in the last year.  B3 capital should have increased by even more - maybe $30Bn.  I don't know if that is sustainable (sounds high doesn't it?) but that kinda implies they could return $20Bn in capital (i.e. 25%) each year and still be growing their Basel 3 buffer.

 

Can you explain your thinking on DTA treatment?  My understanding is that DTA's are generally not counted as capital under the proposed B3 rules, so that (all else equal) capital ratios will be lower than B1.

 

I think the thought is (at least this is what they said on the conference call) that the DTA is not counted right now, but they will earn real capital by the time the actual rules hit.  In other words, the DTA asset will be a real asset by the time it matters.

[xazp]

Can you explain your thinking on DTA treatment?  My understanding is that DTA's are generally not counted as capital under the proposed B3 rules, so that (all else equal) capital ratios will be lower than B1.

DTA's are important and the reason that I think analysts constantly underestimate BAC's capital generation abilities.  And it's a good way to understand the ultimate shareholder payouts of the big banks (BAC, C, JPM, WFC).

 

Under Basel 3, there are various classes of capital that have a restricted value.  For DTA's, the rule is, DTA's can contribute no more than 10% of your capital.  So if you think about, umm, the companies that have been excellent at losing money in the past, they are the ones with DTA's over 10% of capital.  BAC and C are in the penalty box, JPM and WFC aren't. 

 

BAC's guidance is that they can use DTAs at 50% of earnings.  So as those DTAs convert from non-counted capital into real capital, you'll see BAC's B3 capital grow at 150% of earnings.  Said another way, since they seemingly will reach their B3 target this year, 150% of future earnings should be returnable to shareholders (minus some buffer).  This is why I expect BAC to surprise to the upside with buybacks, eventually. 

 

C is in the same position, except, their DTAs are in the wrong jurisdiction.  C is profitable overseas, but breakeven in the US (where the bulk of their DTA's reside), so they don't get the 50% bonus that BAC has - yet.  C is another conversation, but the trigger for their DTA usage is tied to citiholdings losses subsiding. 

 

[bathtime]

Here's a perspective on BAC from a firm recently short it for a trade, for what it's worth.:

 

http://app.hedgeye.com/unlocked_content/21953-a-nim-ble-way-to-look-at-bank-stocks (Chart at the link)

 

-----

 

If you’re thinking of investing in bank stocks, you should understand  net interest margin, or “NIM” for short. It refers to the dollars of interest income less the dollars of interest expense divided by the average interest earning assets in the period. This is a very important metric for us when we look at the health of the big banks like Bank of America (BAC), JP Morgan (JPM), etc. When a company’s NIM changes, even by a few basis points, it puts a hurting on earnings power.

 

Take Bank of America, for example, who saw its NIM compress 30 basis points quarter-over-quarter. Per Hedgeye’s Managing Director of Financials Josh Steiner:

 

“To put this in perspective, the company lost $1.27 billion in quarterly earnings power, or roughly $5 billion in annual earnings power in just one quarter! On a per share after-tax basis, that works out to $0.34 cents in full-year earnings per share. While that may not sound like a lot, Bank of America is only expected to earn $0.55 in 2012 and $0.94 in 2013, so taking a hit of $0.34 in a single quarter is big deal. Remember, that hit is recurring, not one time.”

 

The above chart represents the six quarters “performance” of NIM for some of the biggest banks out there. It gives you an idea of why banks’ earnings are getting squeezed as NIM compresses; they’re essentially losing out on a big chunk of money every report.

 

On the macro side of things, remember that we’re currently in a low-yield, low-rates environment courtesy of the Federal Reserve. Ever heard of bankers doing 3/6/3? Borrow at 3%, lend at 6%, be on the golf course by 3pm. That doesn’t really work the same way anymore. It’s harder to earn interest in this environment and there’s no longer a 300 basis point spread like there used to be back in the day.

 

What’s the end game to all this?

 

So long as the long end of the curve keeps falling (which it is), and banks remain asset sensitive (which they are), then you should reasonably expect to see NIM come under greater and greater pressure, which, in turn, puts pressure on bank earnings. Bank earnings, NIM – remember to keep your eye on this come Q3.

---------

[Kraven]

Here's a perspective on BAC from a firm recently short it for a trade, for what it's worth.:

 

http://app.hedgeye.com/unlocked_content/21953-a-nim-ble-way-to-look-at-bank-stocks (Chart at the link)

 

-----

 

If you’re thinking of investing in bank stocks, you should understand  net interest margin, or “NIM” for short. It refers to the dollars of interest income less the dollars of interest expense divided by the average interest earning assets in the period. This is a very important metric for us when we look at the health of the big banks like Bank of America (BAC), JP Morgan (JPM), etc. When a company’s NIM changes, even by a few basis points, it puts a hurting on earnings power.

 

Take Bank of America, for example, who saw its NIM compress 30 basis points quarter-over-quarter. Per Hedgeye’s Managing Director of Financials Josh Steiner:

 

“To put this in perspective, the company lost $1.27 billion in quarterly earnings power, or roughly $5 billion in annual earnings power in just one quarter! On a per share after-tax basis, that works out to $0.34 cents in full-year earnings per share. While that may not sound like a lot, Bank of America is only expected to earn $0.55 in 2012 and $0.94 in 2013, so taking a hit of $0.34 in a single quarter is big deal. Remember, that hit is recurring, not one time.”

 

The above chart represents the six quarters “performance” of NIM for some of the biggest banks out there. It gives you an idea of why banks’ earnings are getting squeezed as NIM compresses; they’re essentially losing out on a big chunk of money every report.

 

On the macro side of things, remember that we’re currently in a low-yield, low-rates environment courtesy of the Federal Reserve. Ever heard of bankers doing 3/6/3? Borrow at 3%, lend at 6%, be on the golf course by 3pm. That doesn’t really work the same way anymore. It’s harder to earn interest in this environment and there’s no longer a 300 basis point spread like there used to be back in the day.

 

What’s the end game to all this?

 

So long as the long end of the curve keeps falling (which it is), and banks remain asset sensitive (which they are), then you should reasonably expect to see NIM come under greater and greater pressure, which, in turn, puts pressure on bank earnings. Bank earnings, NIM – remember to keep your eye on this come Q3.

---------

 

In my view, this kind of analysis misses the point completely.  This analysis would make perfect sense in a "normal" market for bank valuations.  When you have a bank trading at 40% of BV, what does it matter whether it earns X or X-1?  It's not as if BAC is doing something differently than any other bank, they are all in the same boat (as it relates to NIMs being under pressure).  So, so what that NIMs are getting squeezed.  No profitable bank should ultimately be selling for less than BV.  If BAC was at BV right now, I could see having this discussion, but not now.  Analysts miss the point entirely.  BAC is seen as "risky" while WFC is seen as "safe", yet BAC is 40% of BV while WFC is 140% of BV or so.  I'd be worried about declining NIMs with something trading at a premium. 

[onyx1]

Can you explain your thinking on DTA treatment?  My understanding is that DTA's are generally not counted as capital under the proposed B3 rules, so that (all else equal) capital ratios will be lower than B1.

DTA's are important and the reason that I think analysts constantly underestimate BAC's capital generation abilities.  And it's a good way to understand the ultimate shareholder payouts of the big banks (BAC, C, JPM, WFC).

 

Under Basel 3, there are various classes of capital that have a restricted value.  For DTA's, the rule is, DTA's can contribute no more than 10% of your capital.  So if you think about, umm, the companies that have been excellent at losing money in the past, they are the ones with DTA's over 10% of capital.  BAC and C are in the penalty box, JPM and WFC aren't. 

 

BAC's guidance is that they can use DTAs at 50% of earnings.  So as those DTAs convert from non-counted capital into real capital, you'll see BAC's B3 capital grow at 150% of earnings.  Said another way, since they seemingly will reach their B3 target this year, 150% of future earnings should be returnable to shareholders (minus some buffer).  This is why I expect BAC to surprise to the upside with buybacks, eventually. 

 

C is in the same position, except, their DTAs are in the wrong jurisdiction.  C is profitable overseas, but breakeven in the US (where the bulk of their DTA's reside), so they don't get the 50% bonus that BAC has - yet.  C is another conversation, but the trigger for their DTA usage is tied to citiholdings losses subsiding.

 

Thanks Race/xazp.  I see the guidance in the CC and what you say makes sense.  DTA's are valued at $0 for B3, but they can still generate capital incrementally as earnings are recognized. Thus, capital generated > earnings.

[bathtime]

Thanks for your take on that Kraven! (And yours below bmichaud.)

[bmichaud]

Here's a perspective on BAC from a firm recently short it for a trade, for what it's worth.:

 

http://app.hedgeye.com/unlocked_content/21953-a-nim-ble-way-to-look-at-bank-stocks (Chart at the link)

 

-----

 

If you’re thinking of investing in bank stocks, you should understand  net interest margin, or “NIM” for short. It refers to the dollars of interest income less the dollars of interest expense divided by the average interest earning assets in the period. This is a very important metric for us when we look at the health of the big banks like Bank of America (BAC), JP Morgan (JPM), etc. When a company’s NIM changes, even by a few basis points, it puts a hurting on earnings power.

 

Take Bank of America, for example, who saw its NIM compress 30 basis points quarter-over-quarter. Per Hedgeye’s Managing Director of Financials Josh Steiner:

 

“To put this in perspective, the company lost $1.27 billion in quarterly earnings power, or roughly $5 billion in annual earnings power in just one quarter! On a per share after-tax basis, that works out to $0.34 cents in full-year earnings per share. While that may not sound like a lot, Bank of America is only expected to earn $0.55 in 2012 and $0.94 in 2013, so taking a hit of $0.34 in a single quarter is big deal. Remember, that hit is recurring, not one time.”

 

The above chart represents the six quarters “performance” of NIM for some of the biggest banks out there. It gives you an idea of why banks’ earnings are getting squeezed as NIM compresses; they’re essentially losing out on a big chunk of money every report.

 

On the macro side of things, remember that we’re currently in a low-yield, low-rates environment courtesy of the Federal Reserve. Ever heard of bankers doing 3/6/3? Borrow at 3%, lend at 6%, be on the golf course by 3pm. That doesn’t really work the same way anymore. It’s harder to earn interest in this environment and there’s no longer a 300 basis point spread like there used to be back in the day.

 

What’s the end game to all this?

 

So long as the long end of the curve keeps falling (which it is), and banks remain asset sensitive (which they are), then you should reasonably expect to see NIM come under greater and greater pressure, which, in turn, puts pressure on bank earnings. Bank earnings, NIM – remember to keep your eye on this come Q3.

---------

 

In my view, this kind of analysis misses the point completely.  This analysis would make perfect sense in a "normal" market for bank valuations.  When you have a bank trading at 40% of BV, what does it matter whether it earns X or X-1?  It's not as if BAC is doing something differently than any other bank, they are all in the same boat (as it relates to NIMs being under pressure).  So, so what that NIMs are getting squeezed.  No profitable bank should ultimately be selling for less than BV.  If BAC was at BV right now, I could see having this discussion, but not now.  Analysts miss the point entirely.  BAC is seen as "risky" while WFC is seen as "safe", yet BAC is 40% of BV while WFC is 140% of BV or so.  I'd be worried about declining NIMs with something trading at a premium.

 

This is precisely the type of trap bank investors get caught up in - book value literally does not matter unless the entity is being liquidated. If BAC is to be valued as a going concern, as I assume you are doing, then it must be valued according to its earnings power. Where a bank trades relative to book as a going concern is 100% dependent upon the level of profitability relative to book. So....

 

If WFC earns the mid-point of its 12-15% ROE target, or 13.5%, and it has a cost of equity of 10%, then under a no-growth scenario it should trade at 1.35X book value (.135/.1). Whereas, say BAC eventually earns 10% on book as Berkowitz envisions with a 10% cost of equity, BAC should then trade at 1X book. Under this scenario, WFC at 1.35X book and BAC at 1X book, all things equal, have the EXACT same margin of safety.

 

Right now BAC is not even close to earning 10% on its actual book value, thus it deserves to trade at discount to book - likewise, WFC just earned over 12% on book this quarter.....

[racemize]

 

If WFC earns the mid-point of its 12-15% ROE target, or 13.5%, and it has a cost of equity of 10%, then under a no-growth scenario it should trade at 1.35X book value (.135/.1). Whereas, say BAC eventually earns 10% on book as Berkowitz envisions with a 10% cost of equity, BAC should then trade at 1X book. Under this scenario, WFC at 1.35X book and BAC at 1X book, all things equal, have the EXACT same margin of safety.

 

Right now BAC is not even close to earning 10% on its actual book value, thus it deserves to trade at discount to book - likewise, WFC just earned over 12% on book this quarter.....

 

sure, that makes sense in the short-term, but I think most of us are looking to what will happen in 3-5+ years, not the next 1-2.  Though maybe you are not given your short-term catalyst quote from Klarman?  I don't really understand that line of thinking though, since you have to start thinking about the reactions of people rather than what has to happen eventually.  It is certainly something that I am not good enough to even attempt.

 

To me, the best advantage I have (and I think many on this board) is time horizon--we don't need to worry about the short-term issues and can get outsized gains when they come eventually.  We don't have to bother guessing when it will come, just that it will.

[hyten1]

at the end of the day an asset is value by its earnings power (except for liquidations etc). BAC's earnings power as of today is pathetic. BAC would eventually need to get their earnings yield closer to 10% otherwise there is some serious problem here.

 

would like to hear everyone's thought on the factors that has contributed to BAC's earning no where near 10% of book.

 

[hyten1]

one of my major concern with bac is with all their current issue, and cost cutting, worrying about basel ratios etc. are they hurting their franchise in some material permanent way? letting its competitors (especially WFC) take market share/biz away from BAC.

 

BAC has a huge deposit base, this is both a positive and a negative, especially when you do not do the corresponding about of lending?

[Kraven]

This is precisely the type of trap bank investors get caught up in - book value literally does not matter unless the entity is being liquidated. If BAC is to be valued as a going concern, as I assume you are doing, then it must be valued according to its earnings power. Where a bank trades relative to book as a going concern is 100% dependent upon the level of profitability relative to book. So....

 

If WFC earns the mid-point of its 12-15% ROE target, or 13.5%, and it has a cost of equity of 10%, then under a no-growth scenario it should trade at 1.35X book value (.135/.1). Whereas, say BAC eventually earns 10% on book as Berkowitz envisions with a 10% cost of equity, BAC should then trade at 1X book. Under this scenario, WFC at 1.35X book and BAC at 1X book, all things equal, have the EXACT same margin of safety.

 

Right now BAC is not even close to earning 10% on its actual book value, thus it deserves to trade at discount to book - likewise, WFC just earned over 12% on book this quarter.....

 

Damn, you brought out the big guns with cost of capital.  I guess there's not much else to say.  Those calculations are always accurate.

 

I think you need to step back and think about the real world and not a B-school textbook.  You missed my point completely.  You might be right that at 1.35x BV and 1x BV WFC and BAC have the same MOS.  I'd argue that at that point they both have about zero MOS and are fully valued.  But what you are missing is that WFC IS at 1.35x BV and BAC is at 40% BV, not 1x BV.  So given that I read somewhere along the way that price determines MOS, which stock has the higher MOS?    Your other mistake is using current earnings as the sole ingredient for your earnings power analysis.  It would seem as if you are using GAAP earnings in this case as well.  A bank can't properly be valued on that basis. 

 

In the real world, a profitable bank with good assets would not be sold for less than BV.  I have no doubt that someday BAC will be at BV again.  I have no idea when that might be.  Of course the risk is that when that time comes BV may not be where people want it to be.

 

One last thing, I could disagree with you more that BV only matters in liquidation.  It may not be something concrete that you can plug into your fancy models, but it matters.  There isn't a direct correlation between BV and valuation, but as Graham said, it's the difference between the Wall St and the Main St approach. 

[Parsad]

at the end of the day an asset is value by its earnings power (except for liquidations etc). BAC's earnings power as of today is pathetic. BAC would eventually need to get their earnings yield closer to 10% otherwise there is some serious problem here.

 

would like to hear everyone's thought on the factors that has contributed to BAC's earning no where near 10% of book.

 

Well it is trading near half of it's liquidation value...so do you give that any value if earnings are mostly being used to run off poor loans and litigation in the near future?  Do you believe that all of that earning power will be used to permanently pay off loan losses and litigation, or do you think at some point in time the litigation and losses will subside? 

 

Finally, let me ask you...does anyone even talk about BP's litigation issues and losses from two years ago today, and has BP's earning power been permanently impaired by any past settlements or losses?  No one today even really remembers the oil spill in the Gulf or the ensuing litigation.  Cheers!

[Kraven]

one of my major concern with bac is with all their current issue, and cost cutting, worrying about basel ratios etc. are they hurting their franchise in some material permanent way? letting its competitors (especially WFC) take market share/biz away from BAC.

 

BAC has a huge deposit base, this is both a positive and a negative, especially when you do not do the corresponding about of lending?

 

I'm always fascinated by the love on this board for WFC.  I know everyone thinks for themselves and all that, but I think Buffett rubs off a little too much sometimes.  WFC has great PR I will say that.  I am curious as to what market share BAC is losing to WFC exactly.  Please provide details.  Is it in investment banking?  Now I know, I know, WFC only does the safest business and has no investment banking business to taint their saintly image.  I guess the bankers in San Fran, NYC and Charlotte are mirages.  Ok, well, WFC didn't do any of those awful securitizations or CDOs or structured products, did they?  Again, the bankers must be ghosts.  The truth is that WFC tried to get into all those businesses and failed.  They didn't stay away because they were purer than the driven snow.  They still are trying to pump them out too - they got the old Wachovia's team in Charlotte doing what they can.  Legacy WFC people weren't thrilled that they now answer to legacy Wachovia bankers.  So where, pray tell, is WFC taking business from BAC?  Because we all know that when one needs a mortgage, it doesn't just come down to the rate.