BAC-WT - Bank of America Warrants

[jch548]

The latest "Grant's Interest Rate Observer" has a nice piece on a rising rate environment and financials. Someone from the Third Avenue Real Estate Value Fund was bullish on the bank tarp warrants due to increased net interest margins for the banks. More in depth examples were Met Life and Schwab as some of the actual mechanics were discussed explaining how these companies benefit along with some accounting stuff. XAZP has it right here I believe.

[dcollon]

You all have made some interesting points.  This is a good discussion and it will be interesting to see how it plays out over time. 

[Cardboard]

What is missing in the replies is the impact from hedging and derivatives. It is a lot more complicated than just straight loans, investment and deposits. Interest rates derivatives have gigantic notional values and unlike AIG, mega banks have not shrunk derivatives since the crisis. Who is going to hold the bag on sudden climb?

 

Hence my concerns. I doubt that Dimon has glossed over this issue especially after the Whale disaster and when he says that he will make money, he means it. Just like when he exited subprime and likely bought hedges around it. Thompson's answer on the other hand of not being prepared or simply willing to absorb the shock as a "temporary" hit on AOCI is unacceptable. Does it include the full derivatives impact?

 

Cardboard

[ERICOPOLY]

What is missing in the replies is the impact from hedging and derivatives. It is a lot more complicated than just straight loans, investment and deposits. Interest rates derivatives have gigantic notional values and unlike AIG, mega banks have not shrunk derivatives since the crisis. Who is going to hold the bag on sudden climb?

 

Rates fell pretty hard in one direction (down) during the crisis and I'm not sure what happened to the megabanks derivatives books.  I don't remember them blowing up from that, it was the other stuff that they were doing wrong that caused the trouble.  So if rates go back up, what is the reason why it will be worse than when they go down?

 

I believe very strongly that the drop in rates to these levels would have been the far more surprising scenario -- I mean, it's not like these big banks today can't believe that rates will go back to normal levels again.  Everyone believes that rates will at some point reach higher levels again.  But surely many were caught completely by surprise when rates dropped to the lows of recent years.

 

So... we now have the scenario that everyone is expecting (rising rates) ahead of us, and the scenario that few expected (falling rates) behind us.  The banks are just waiting for their books to blow up from this widely expected event?

[Cardboard]

Well, just ask yourself this question. Which corporation did you ever read about that was buying hedges or financial protection on their debt against lower interest rates?

 

Cardboard

[Kraven]

What is missing in the replies is the impact from hedging and derivatives. It is a lot more complicated than just straight loans, investment and deposits. Interest rates derivatives have gigantic notional values and unlike AIG, mega banks have not shrunk derivatives since the crisis. Who is going to hold the bag on sudden climb?

 

Rates fell pretty hard in one direction (down) during the crisis and I'm not sure what happened to the megabanks derivatives books.  I don't remember them blowing up from that, it was the other stuff that they were doing wrong that caused the trouble.  So if rates go back up, what is the reason why it will be worse than when they go down?

 

I believe very strongly that the drop in rates to these levels would have been the far more surprising scenario -- I mean, it's not like these big banks today can't believe that rates will go back to normal levels again.  Everyone believes that rates will at some point reach higher levels again.  But surely many were caught completely by surprise when rates dropped to the lows of recent years.

 

So... we now have the scenario that everyone is expecting (rising rates) ahead of us, and the scenario that few expected (falling rates) behind us.  The banks are just waiting for their books to blow up from this widely expected event?

 

I don't believe it is possible to read the derivatives section in a bank's disclosure or financial statements and have any sense whatsoever as to what the impact will be upon movement in interest rates.  Those books are fluid beyond belief and even if not fluid it likely would not be possible to do more than provide a good guesstimate.  The people on the desks working with the book every day couldn't tell you with any degree of certainty what the result will be.  So why people believe that reading the 10-K will afford them a window into things is beyond me. 

[Cardboard]

"So why people believe that reading the 10-K will afford them a window into things is beyond me."

 

Exactly. So it all boils down to trust, competence of management and I would say a little bit of luck in them managing such a dynamic and risky house of cards. The Whale disaster is a reminder of what can happen, and it is a very small disaster, at what looks like a well managed institution. 

 

Regarding interest rates derivatives, the banks overall have to be net insurers against higher rates. However, like you said Kraven, it is impossible to find out the true exposure in their financial statements with so many durations and related hedges. And these hedges are mostly with other banks so you can start to appreciate how worthwhile their hedges could be in a full fledge crisis.

 

Now, if there is a crisis due to higher interest rates, it will likely bring back down these rates along with the economy. The question remains who is going to hold the bag and default under such scenario before rates head back down? I have no way to tell. I simply didn't like Thompson's nonchalant answer. And these guys have yet to demonstrate any kind of earning power or decent return on assets. Sounded like another excuse for a coming poor Q2 and a likely weak Q3 and on and on. So yes, I am getting frustrated and nervous holding something carrying such risk while missing expectations has been the norm and could continue.

 

Cardboard

[Kraven]

"So why people believe that reading the 10-K will afford them a window into things is beyond me."

 

Exactly. So it all boils down to trust, competence of management and I would say a little bit of luck in them managing such a dynamic and risky house of cards. The Whale disaster is a reminder of what can happen, and it is a very small disaster, at what looks like a well managed institution. 

 

Regarding interest rates derivatives, the banks overall have to be net insurers against higher rates. However, like you said Kraven, it is impossible to find out the true exposure in their financial statements with so many durations and related hedges. And these hedges are mostly with other banks so you can start to appreciate how worthwhile their hedges could be in a full fledge crisis.

 

Now, if there is a crisis due to higher interest rates, it will likely bring back down these rates along with the economy. The question remains who is going to hold the bag and default under such scenario before rates head back down? I have no way to tell. I simply didn't like Thompson's nonchalant answer. And these guys have yet to demonstrate any kind of earning power or decent return on assets. Sounded like another excuse for a coming poor Q2 and a likely weak Q3 and on and on. So yes, I am getting frustrated and nervous holding something carrying such risk while missing expectations has been the norm and could continue.

 

Cardboard

 

Cardboard, with all due respect, I think you are getting yourself all worked up over this for nothing.  If you're expecting Financial Crisis Part Deux, then don't invest in any financial.  It isn't just going to be BAC, JPM, etc that have issues.  Further, if we have another financial crisis what is going to be fine?  Either things will work themselves out or we will all be looking for ammo and canned goods.  Personally, I don't expect a problem due to rising interest rates.  That has happened before and with the tentative financial system I think central bankers will more than telegraph their moves in advance.  That's just me though.

 

I like to think about a speech Ben Graham made in the 60s.  I'm paraphrasing here, but he said one of the issues people raise in terms of investing is what to do in light of the fact that there could be a nuclear war.  His answer was essentially who knows, life could be over then and what difference will investing make, so we need to assume it won't happen.  I think the same thing here. 

 

A financial crisis (again) the likes of which we saw in 2008-2009 could have various implications that can't be predicted.  So if you think financials can't weather the storm, then pass on them, but you're not going to get there by deciding that one bank has better controls than another.  I can't envision a situation at this point where there are winners and losers among the money center banks.  I don't see BAC going down while Jamie is sipping champagne and smiling. 

 

So to borrow a phrase from a preview I just saw for a movie called Pacific Rim, why don't you go ahead and cancel the apocalypse.  There's nothing you can do about it anyway.

[Cardboard]

Sure, if there is another major crisis then all financials and most if not all sectors will go way down, so why invest now if I am convinced about that scenario? That is not what I am trying to get at.

 

The problem I have with BAC is that it has been a serial underperformer. The recent buyback is a joke and some people have noticed that they did not take advantage of lower prices. On the dividend, I don't get paid to wait around while they do their turnaround. On compensation, bonuses will be paid to achieve sub-par results. On dilution, they issue a lot more stock than they will ever buyback at current rate. On cost cutting and earnings, I have yet to see much improvement despite making a ton of adjustments to "recurring" earnings at every quarterly report that I get.

 

The entire thesis around BAC is about getting back to a reasonable ROA or maybe $2 per share in EPS, but as I have pointed out in the last paragraph, there are many self-inflicted head winds to get there. To make real money going forward on this investment, since it competes with others for my hard earned dollars, they have to get there quickly: 2 to 3 years max. So I am getting impatient when I hear the CFO talking about a negative impact related to interest rates. What I would like to see in terms of behaviour is more: "If things continue, rates should go up and this will hurt us, however we are proactive and doing this, this and this to offset the impact and even benefit from it."

 

Things have simply changed. Before, it was the place to be with very few better alternatives. Now, there has been a crash in many independent oil companies and resource stocks (if the world does not fall apart, there should be opportunity there as well) and there are small caps trading at really low valuations. The only thing holding me back in BAC at the moment is not being around $15 and the impact of taxation. So I am kind of giving them one more chance with Q2 and if I still see a few pennies in earnings type quarter, then I am out.

 

Cardboard

[ERICOPOLY]

The recent buyback is a joke and some people have noticed that they did not take advantage of lower prices.

 

So I am getting impatient when I hear the CFO talking about a negative impact related to interest rates.

 

Is it a negative impact?  I should think we would all be happy to spend $11b of capital in order to see such a boost in EPS.  You are expressing your disappointment in the lack of that very scenario (lack of larger buyback).

 

The "negative" impact related to 1% jump in interest rates is better for EPS than an $11b buyback with no rate movement.

 

Thompson stating that the hit to capital would be 3x the improvement in earnings is the key statement -- as long as the incremental earnings improvement is awarded more than P/E of 3x by the market, then it's a positive event for the stock (if they have the capital to afford the hit).

 

[ourkid8]

In all fairness to BAC, in May they called $5.5B in preferred which will be a huge boost to the bottom line.  I was honestly not expecting any stock to be repurchased until this action has been completed.  This is prudent capital management and something all businesses should be doing in this regulatory environment. 

 

Look at another company facing the same regulatory scrutiny, AIG could have also repurchase a ton of stock under Book value and at lower valuations creating shareholder value BUT they are waiting for ILFC sale to happen to strengthen their balance sheet before returning capital back to shareholders.  Again, prudent capital management. 

 

Obviously all us shareholders would have loved for them to maximize the buyback immediately (complete in 2-3 weeks) while calling the preferred at the same time but there is no way the regulators would have allowed them to execute $10.5B in capital return all the in the same month. 

 

BTW: The stock is still selling for below TBV

 

Thanks,

S

 

 

 

The recent buyback is a joke and some people have noticed that they did not take advantage of lower prices.

 

 

[mankap]

I also think that expansion of earnings due to steepening of yield curve will far outweigh the hit to balance sheet.

I do not expect parallel shift in yield curve but rather steepening of yield curve which is positive of banks.

This will result in increased in earning because of two reasons

Improvement in NIMS

Loan growth

 

Problem with BAC is not the capital level but the earning power.If BAC can show growth in earnings, it will attract higher valuations. Higher earnings could mean higher dividend and higher multiples.

[meiroy]

If BAC can show growth in earnings, it will attract higher valuations. Higher earnings could mean higher dividend and higher multiples.

 

If the company is moved from the "discount to TBV" category to the "earnings" (or whatever) category, then wouldn't it be safe to assume that if they can have better earnings so would various other banks? There are financials out there with far superior historical ROA and ROE which are trading around P/E 10, have increasing dividends etc.

 

 

 

 

[redskin]

What makes you think they have not started the buyback?  They were approved for the buyback on March 7.  I think they have stated that the buyback would begin in the 2nd quarter.  The stock closed at 12.28 on March 7th and has traded as low as 11.23 in the 2nd quarter.  I would think they have been consistent buyers of the stock throughout the quarter.  We will find out in July when they announce Q2 earnings.

 

Sure, if there is another major crisis then all financials and most if not all sectors will go way down, so why invest now if I am convinced about that scenario? That is not what I am trying to get at.

 

The problem I have with BAC is that it has been a serial underperformer. The recent buyback is a joke and some people have noticed that they did not take advantage of lower prices. On the dividend, I don't get paid to wait around while they do their turnaround. On compensation, bonuses will be paid to achieve sub-par results. On dilution, they issue a lot more stock than they will ever buyback at current rate. On cost cutting and earnings, I have yet to see much improvement despite making a ton of adjustments to "recurring" earnings at every quarterly report that I get.

 

The entire thesis around BAC is about getting back to a reasonable ROA or maybe $2 per share in EPS, but as I have pointed out in the last paragraph, there are many self-inflicted head winds to get there. To make real money going forward on this investment, since it competes with others for my hard earned dollars, they have to get there quickly: 2 to 3 years max. So I am getting impatient when I hear the CFO talking about a negative impact related to interest rates. What I would like to see in terms of behaviour is more: "If things continue, rates should go up and this will hurt us, however we are proactive and doing this, this and this to offset the impact and even benefit from it."

 

Things have simply changed. Before, it was the place to be with very few better alternatives. Now, there has been a crash in many independent oil companies and resource stocks (if the world does not fall apart, there should be opportunity there as well) and there are small caps trading at really low valuations. The only thing holding me back in BAC at the moment is not being around $15 and the impact of taxation. So I am kind of giving them one more chance with Q2 and if I still see a few pennies in earnings type quarter, then I am out.

 

Cardboard

[buylowersellhigh]

any new news?  general malaise?

[mankap]

Is it good time to add to BAC position

[Kraven]

any new news?  general malaise?

 

This can't be a serious post.

[buylowersellhigh]

I didn't see any new news.  Thought there might be some court news.  While 3.6% down isn't much, just seem more than the market. 

[valueinvesting101]

Might be related to

http://www.bloomberg.com/news/2013-06-21/u-s-weighs-doubling-leverage-standard-for-biggest-banks.html

 

WFC is up

[Uccmal]

Might be related to

http://www.bloomberg.com/news/2013-06-21/u-s-weighs-doubling-leverage-standard-for-biggest-banks.html

 

WFC is up

 

Do you think? :-X

 

5.1% to 6% - they will likely reach that years ahead of any implementation.  Can you say market overreaction....

 

Sold around 50% of my puts... not buying anything right now.

 

 

[xazp]

A similar scare happened almost exactly 3 months ago - proposed banking legislation.  That turned out to be a good time to buy - it pushed BAC to $11, so it's up 15% since then (and was up 25%). 

 

My bet is a combination of A) watering down the rules; B) long implementation time;  C) naturally growing equity levels -- will render this not so painful.  For BAC and C in particular, they're eager to get rid of those old, non-performing assets so it's consistent with their strategy anyway. 

 

But there will be some pain if A) they adopt IFRS accounting for derivatives and B) they force them to get to 6% in short order. 

 

I much prefer they modify the RWA system whichever way they like.  It makes little sense to me to consider all assets on the same basis - cash, treasuries, performing mortgage, non-performing mortgage, defaulted corporate bond, stock holdings.  Weighting is much more sensible, but ... them's the rules. 

 

 

Might be related to

http://www.bloomberg.com/news/2013-06-21/u-s-weighs-doubling-leverage-standard-for-biggest-banks.html

 

WFC is up

 

Do you think? :-X

 

5.1% to 6% - they will likely reach that years ahead of any implementation.  Can you say market overreaction....

 

Sold around 50% of my puts... not buying anything right now.

[mankap]

May be that is why WFC is up 2.34%.

The article states that WFC is the only big bank which already has capital>6%.

[mankap]

When Fed starts raising short term rates(2015), probably it will raise 2% in 2 years.This could mean 7.4B gain in Net Income in addition to reduction in expenses.

 

The potential impact was highlighted by Bank of America BAC -1.55% finance chief Bruce Thompson during a recent conference. BofA said in its most recent securities filing that an upward shift in longer-dated yields of a percentage point would bolster net interest income by around $1.6 billion, pretax. A parallel shift, meaning both short and long rates rise by a similar amount, could lead to a $3.7 billion gain.

[ERICOPOLY]

May be that is why WFC is up 2.34%.

The article states that WFC is the only big bank which already has capital>6%.

 

Remember that I'm the guy who doesn't understand what a call report is...

 

So keeping that in mind, can't these banks just sell their highly liquid short term treasuries to get their leverage ratios up?  I thought this whole thing was a tempest in a teapot using that logic.  They cited BofA at 5.1% leverage ratio, yet their Basel III was 8.5%.  So there is a lot of zero-risk government securities that can easily be thrown overboard in order to get up to 6%, right?  Or not so much?

 

Sincerely just wanting to know more and willing to expose my ignorance while doing so.

[xazp]

So there is a lot of zero-risk government securities that can easily be thrown overboard in order to get up to 6%, right?  Or not so much?  >>

 

There isn't enough information to answer your question.  Strictly speaking, both cash and treasuries are "assets."  Selling treasuries to gain cash, then, is a wash. The banks are arguing that cash & treasuries should not be counted as assets for purposes of the leverage ratio (sensible to me, but, I don't make the rules).  The leverage ratio, while it seems simple, is highly dependent on what is or isn't counted as an asset. 

 

This is Fed VC Hoenig's data on leverage ratios:  http://www.fdic.gov/about/learn/board/hoenig/capitalizationratios.pdf  He's the one pushing for this. 

 

I've spent some time analyzing it.  Without going into a lot of detail - the left yellow column is leverage ratio under U.S. GAAP, right yellow column is leverage ratio under IFRC (European) accounting.

 

Under U.S. GAAP everyone is already close enough to the 6% level that it wouldn't be a big deal.  If US regulators choose IFRC they are much further away.  Main difference between the two is accounting for derivatives. 

 

Key observation (and this is solely mine) - U.S. banks can change the way they handle derivatives, and IFRC numbers will converge to US GAAP numbers.  This is probably a hassle, but my reading of the rules says it's not a big hassle - they have to change master netting agreements to conform to IFRC rules on netting instead of US GAAP.

 

I formerly said choosing IFRC rules + 6% + short time frame would probably be painful -- but after reading things, I think they can converge IFRC towards US GAAP numbers if that is what the regulators want. 

 

May be that is why WFC is up 2.34%.

The article states that WFC is the only big bank which already has capital>6%.

 

Remember that I'm the guy who doesn't understand what a call report is...

 

So keeping that in mind, can't these banks just sell their highly liquid short term treasuries to get their leverage ratios up?  I thought this whole thing was a tempest in a teapot using that logic.  They cited BofA at 5.1% leverage ratio, yet their Basel III was 8.5%.  So there is a lot of zero-risk government securities that can easily be thrown overboard in order to get up to 6%, right?  Or not so much?

 

Sincerely just wanting to know more and willing to expose my ignorance while doing so.