BAC-WT - Bank of America Warrants

[finetrader]

keep the good time rolling!

 

[jmaes]

 

I've never understood this reasoning:

 

If he sells now, his equation for future returns is:

P (1-T)(1+r)^x

This reflects the principal being reduced and then compounded.  Selling later produces

P (1+r)^x (1-T)

Which reflects the full principal compounding and reduced by future taxes. 

 

Since multiplication is commutative, it doesn't matter when you pay taxes as long as r, x, and T are all held equal. The question should then be will you pay higher taxes now or later and that should be the only determination necessary as long as taxes due are paid out of principal and earnings.  Am I wrong?

 

I think you should compare it like this:

if you sell now, your equation for future returns is:

P (1-T)(1+r)^x(1-T)

because you need to pay tax again for your new investment.

 

I may be wrong, because I live in Belgium and don't need to pay taxes on equity returns.

[Liberty]

Anyone had a chance to listen to the conference call? Anything interesting?

[shalab]

BAC management hasn't done a great job in improving business - they have lagged in mortgages even after spending a fortune on countrywide. They did what was obvious - just jumping over one foot hurdles. This quarter, their deposit growth has slowed and I won't be surprised if WFC overtook them next quarter in total deposits. ( WFC is now in the trillion+ league already with a small lag with BAC ) In addition, the dividends on preferred has increased which is surprising.

 

I would have expected them to be more aggressive in reducing dilution - hasn't happened. WFC is also in the same boat ( regarding dilution ) - despite their share buyback in the billions, the share count has barely budged. They should buy back the warrants before upping the dividend and also buy back the Buffett investment.

[Uccmal]

transcript:

 

http://seekingalpha.com/article/1553162-bank-of-america-s-ceo-discusses-q2-2013-results-earnings-call-transcript

[Liberty]

Thanks Uccmal.

 

There's a question about buybacks (which unfortunately doesn't elucidate much about why they only spent 1 billion):

 

Guy Moszkowski - Autonomous Research

 

[...]

 

On the shares, you did initiate the share repurchase. You talked about that. But there was still a fairly meaningful amount of share creep in the quarter. Was that just employee grants? Or I would have expected to see those more in the first quarter. And should we expect that we’re, at this point, kind of at a high for the year in terms of the share count? Or should it head back down to where it was, say, in the first quarter?

 

Bruce Thompson - Chief Financial Officer

 

If you flip back to the balance sheet data that we present on page six, you can see that the actual number of outstanding shares for the quarter came down by 80 million, which is the 80 million shares that we told you we repurchased. The only variation in the supply chain on a fully diluted basis is the treatment of the 700 million shares that were associated with the Berkshire investment. And depending on the price of the stock, as well as where the preferred shares are, that fully diluted share count can bounce around a little bit. But on a pure shares outstanding, we came down by the 80 million that we show on slide six

[Parsad]

transcript:

 

http://seekingalpha.com/article/1553162-bank-of-america-s-ceo-discusses-q2-2013-results-earnings-call-transcript

 

Pretty detailed conference call with a lot of questions.  I know Mike Mayo has a pretty good reputation, but I thought the last question on the LAS reserves was kind of stupid.  How is BAC supposed to comment on something that is in the process of a settlement, and then give guidance if the settlement is approved or kicked out for future quarters?  Silly!  Cheers!

[FCharlie]

Is anyone disappointed with anything *other* than the buyback?

 

 

I'm very happy with the quarter. It's nice to see the enormous earnings power begin to show. Remember we're still dealing with $2 billion per quarter in LAS expense.

 

The only thing that worries me is the giant hit to the balance sheet from the comprehensive income and changes in values in their portfolio. Ouch.  Imagine the impact if the Fed loses control of the bond market and rates really soar.

 

 

[giofranchi]

I don't follow BAC, so I beg your pardon for what might be a silly question... Anyway, someone can tell me why FFH reports mark-to-market, while practically no major bank in the world does so?

 

Can someone comment on Mr. Tyler Durden's article in attachment?

 

Thank you,

 

giofranchi

Bank_Of_America_From_Loss_To_Profit_Thanks_To_Mark-To-Unicorn.pdf

[Parsad]

I don't follow BAC, so I beg your pardon for what might be a silly question... Anyway, someone can tell me why FFH reports mark-to-market, while practically no major bank in the world does so?

 

Can someone comment on Mr. Tyler Durden's article in attachment?

 

Thank you,

 

giofranchi

 

Basically, the value of financial instruments were changing so fast, that certain liquid and illiquid investments meant as longer term, were making the balance sheet's of financial institutions unstable due to the volatility.  FASB 157 for larger institutions was suspended so that stability and confidence could be achieved in the financial system.

 

While I'm a proponent of marked to market accounting, I think the rule needs to be re-examined on how to implement it when reporting.  Maybe a reserve needs to be setup showing the change in valuation in the notes, but not actually run through the P&L until realized.  Berkshire got caught up in this as well with the S&P puts they were underwriting when no actual immediate liability existed.  Cheers!   

[giofranchi]

Basically, the value of financial instruments were changing so fast, that certain liquid and illiquid investments meant as longer term, were making the balance sheet's of financial institutions unstable due to the volatility.   

 

Thank you Parsad!

And I understand what you mean. Yet… imo very complicated stuff…! Volatility until now hasn't been able to destabilize FFH's balance sheet, even if FFH uses marked to market accounting. And this makes me sleep very soundly at night! :)

 

giofranchi

 

[onyx1]

transcript:

 

http://seekingalpha.com/article/1553162-bank-of-america-s-ceo-discusses-q2-2013-results-earnings-call-transcript

 

Pretty detailed conference call with a lot of questions.  I know Mike Mayo has a pretty good reputation, but I thought the last question on the LAS reserves was kind of stupid.  How is BAC supposed to comment on something that is in the process of a settlement, and then give guidance if the settlement is approved or kicked out for future quarters?  Silly!  Cheers!

 

I agree that they can't comment specifically, but I thought it was revealing that Thompson (in answering a question about how much higher the reserve would be in a rejection scenario)  left the door open to reserve being reduced if the settlement doesn't go through:

 

"The first is we’re not going to comment on the ins and the outs of the $8.5 billion, because as you know, technically we’re not a part of that. The second thing as it relates to that that I would say is, and I think if you go back and look at one of the comments that was made, we accrued the $8.5 billion assuming that all 424 trusts were at the point where they got to the 25%, to where there was a negotiation.

 

So at this point, to comment whether or not we think the reserves would be higher or they could be lower is really not appropriate, because right now there’s an $8.5 billion settlement that’s going through the process. We’ve accrued based on what 22 of the largest investors said was a fair deal, and as you know, when we set up the reserves, we applied that same methodology to a variety of our other exposures. And to speculate or to comment before then, given where we are in this, I just don’t think is appropriate. "

 

Since a large portion of the 424 trusts do not meet the 25% threshold, it's plausible that the reserve could go down if the settlement is rejected.

 

[jay21]

I don't follow BAC, so I beg your pardon for what might be a silly question... Anyway, someone can tell me why FFH reports mark-to-market, while practically no major bank in the world does so?

 

Can someone comment on Mr. Tyler Durden's article in attachment?

 

Thank you,

 

giofranchi

 

This is a terrible article.  Any analyst of financial companies knows there are 4 types of accounting for financial instruments:  Available for sale (AFS), trading, equity method, and held to maturity.  It's not like BAC was hiding these losses using some accounting trick.  Most financial institutions (including BRK and MKL) carry their investments as AFS where both gains and losses flow through OCI as opposed to net income.  Also, this does not mean MTM accounting is not being used.  The investments are being carried at FV, it is just the changes in FV are not reported in net income.

[giofranchi]

Also, this does not mean MTM accounting is not being used.  The investments are being carried at FV, it is just the changes in FV are not reported in net income.

 

Sorry jay, I don’t understand: people look at increase or decrease in book value, increase or decrease in earnings. I am perfectly fine with a long term investment that doesn’t affect quarterly or even yearly earnings. But it surely should affect book value. Otherwise, how are you supposed to know what you own?

I repeat, I don’t follow BAC, so probably I am missing something here… even though this is far more general, and goes well beyond the BAC case.

 

giofranchi

 

[SharperDingaan]

Gio, you may want to spend time looking into the mechanics of OCI ..... very revealing.

 

Anything held for trading (asset or liability) or available for sale is marked quarterly, & the difference in valuation since the last mark - applied to OCI. You do exactly the same when valuing your portfolio, & you do it to determine your return on capital. If you really are hedged, your MTM gain or loss should be zero; if you got a MTM loss in a bullish quarter it reflects that you are not actually hedged & that you bet wrong - with a net bearish outlook, if you got a MTM gain in a bullish quarter it reflects that you bet correctly - & that you expect further improvements. A CEO telling the world they are bullish, at the same time they experience an increase in OCI loss, is lying - & you can now prove it. The CEO who did not sell when the bet went their way is market timing - & better have a good explanation as to why they did not unwind. Nobody loves the accountability or discipline.

 

Regulatory capital is simply MV x a risk weight reflecting how risky the asset is; a high risk bond or equity results in zero regulatory capital as it has zero value if it has to be sold today - under adverse conditions; conversely the T-Bill results in 95-100% regulatory capital. The bigger your business (by total assets) & the riskier those assets, the more capital you require in various forms of either equity or CoCo bond. For a given amount of capital you either increase or decrease your business according to how risky your underlying assets are (if risk rises you either recall loans, or cut off the poor credits); if you cannot adjust quickly enough you either put up more capital (billion dollar capital raises), or discontinue lines of business (thereby earning less income & reducing share price). Again, nobody loves the accountability or discipline.

 

Understand the MV effect on regulatory capital, & you will understand the logic behind the FFH investments in Irish & Greek banks. A small improvement in those economies, makes the underlying assets of those banks less risky, & automatically raises their regulatory capital; allowing them to make additional loans (increasing earnings) to goose the economy, & further reduce the riskiness of the underlying assets - increasing regulatory capital further. Every central banker in the world helping you, no further capital raises required, earnings to buy back inflated share count ..... & you sitting there with a nice big equity position at a low cost base.

 

Compare the capital ratios of the FFH bank investments to the big 5 Canadian Banks; if the Canadian Bank had the same capital ratio would you be investing the same way. 

 

SD

 

[jay21]

Also, this does not mean MTM accounting is not being used.  The investments are being carried at FV, it is just the changes in FV are not reported in net income.

 

Sorry jay, I don’t understand: people look at increase or decrease in book value, increase or decrease in earnings. I am perfectly fine with a long term investment that doesn’t affect quarterly or even yearly earnings. But it surely should affect book value. Otherwise, how are you supposed to know what you own?

I repeat, I don’t follow BAC, so probably I am missing something here… even though this is far more general, and goes well beyond the BAC case.

 

giofranchi

 

The MTM change affects book value but not through net income, its through a separate line called OCI. This is true of BRK and MKL as well. If you look at their income statement, you will not see a good chunk of their investment returns. 

 

If you look at BAC's balance sheet, the majority of securities are reported at FV.  What Tyler is discussing is where the changes in FV are reported (either through OCI or net income).  Regardless of where the changes are reported, book value is still affected.

[giofranchi]

The MTM change affects book value but not through net income, its through a separate line called OCI. This is true of BRK and MKL as well. If you look at their income statement, you will not see a good chunk of their investment returns. 

 

If you look at BAC's balance sheet, the majority of securities are reported at FV.  What Tyler is discussing is where the changes in FV are reported (either through OCI or net income).  Regardless of where the changes are reported, book value is still affected.

 

Ok, that is fine with me!

So, let me be sure I have understood well: the change reported by BAC in BV since Q4 2011 already takes into consideration those $7.6 billion decrease in AFS and marketable equity securities? Have I understood it correctly?

Thank you,

 

giofranchi

 

[giofranchi]

Ok, you have succeeded in forcing me to look for the first time in my life at BAC! ;D

I think what Mr. Tyler Durden is pointing out is that earnings, if not reported MTM, may give a false sense of prosperity… BAC reported a loss of (2,238) billion in 2010, a profit of 1,446 billion in 2011, and a profit of 4,188 billion in 2012. WOW! If BAC is improving so much, so fast, everything should be all right! Shouldn’t it? Unfortunately, BVPS went down from $20.99 in 2010 to $20.24 in 2012… So I think this is what he really means: apparently, a lot of wealth has been created, but in truth it is not so. Despite all the earnings declared, each shareholder owned more at the end of 2010 than he owned at the end of 2012.

Is this completely wrong?

 

giofranchi

 

[jay21]

The MTM change affects book value but not through net income, its through a separate line called OCI. This is true of BRK and MKL as well. If you look at their income statement, you will not see a good chunk of their investment returns. 

 

If you look at BAC's balance sheet, the majority of securities are reported at FV.  What Tyler is discussing is where the changes in FV are reported (either through OCI or net income).  Regardless of where the changes are reported, book value is still affected.

 

Ok, that is fine with me!

So, let me be sure I have understood well: the change reported by BAC in BV since Q4 2011 already takes into consideration those $7.6 billion decrease in AFS and marketable equity securities? Have I understood it correctly?

Thank you,

 

giofranchi

 

Yes.

 

Ok, you have succeeded in forcing me to look for the first time in my life at BAC! ;D

I think what Mr. Tyler Durden is pointing out is that earnings, if not reported MTM, may give a false sense of prosperity… BAC reported a loss of (2,238) billion in 2010, a profit of 1,446 billion in 2011, and a profit of 4,188 billion in 2012. WOW! If BAC is improving so much, so fast, everything should be all right! Shouldn’t it? Unfortunately, BVPS went down from $20.99 in 2010 to $20.24 in 2012… So I think this is what he really means: apparently, a lot of wealth has been created, but in truth it is not so. Despite all the earnings declared, each shareholder owned more at the end of 2010 than he owned at the end of 2012.

Is this completely wrong?

 

giofranchi

 

Tyler would probably agree with what you said, but book value is just a number subject to the rules of accounting.  Is the value of BAC greater now than in 2010?  Imo, yes.

[Sunrider]

Ok, you have succeeded in forcing me to look for the first time in my life at BAC! ;D

I think what Mr. Tyler Durden is pointing out is that earnings, if not reported MTM, may give a false sense of prosperity… BAC reported a loss of (2,238) billion in 2010, a profit of 1,446 billion in 2011, and a profit of 4,188 billion in 2012. WOW! If BAC is improving so much, so fast, everything should be all right! Shouldn’t it? Unfortunately, BVPS went down from $20.99 in 2010 to $20.24 in 2012… So I think this is what he really means: apparently, a lot of wealth has been created, but in truth it is not so. Despite all the earnings declared, each shareholder owned more at the end of 2010 than he owned at the end of 2012.

Is this completely wrong?

 

giofranchi

Hi Gio

 

I would classify the TD piece as sensationalism to generate web traffic. Nothing more. All the banks are in the same boat - if you mark to market very large security portfolios that are sensitive to interest rate movements you'll see huge P&L volatility. It's helpful to remember that accounting rules are made for all firms, not just banks, and whilst MTM is economically sensible, it may lead to undesirable results for some businesses. By undesirable I mean that accountants actually do not want to estimate economic truth as such (or at least, originally that was less of an objective). You can also see that in provisioning rules that originally allowed more of an expected loss approach, then migrated to an incurred loss approach, and are now moving back to an expected loss approach under IFRS9 (forget what the equivalent US standard is called). It's easy to say that we'd like to have financial statements that reflect economic reality at the point of the statement but if you think about the complexities that need to be considered when estimating the value of illiquid instruments you can see why accountants have stepped back a bit from this.

 

So instead of reporting the swing in income it got moved into the OCI line (below the profit line, so to speak). You still have an effect on equity and you can still estimate economic reality, but you've taken the volatility out of the income line. Big gain? Don't know.

 

More importantly, and this is where I see this as sensationalism, it's not the swing you should be concerned with as such, but the quality of the underlying assets. The negative MTM from an increase in interest rates will amortise out over time as the securities approach maturity. As long as there is no default shareholders are no worse of over the full tenor of the portfolio. So the question I ask myself as a bank shareholder - am I happy with the interim volatility and do I believe the portfolio of securities is ultimately good enough quality?

 

One more thing - if you assume no defaults, wealth has actually been created (but that creation in terms of BV accretion) has been masked by the negative MTM.

 

Cheers - C.

[Ross812]

Consider the source too. 'Tyler Durden' is a moniker in reference to Fight Club; a book about bringing down the modern financial system. Great post SharperDingaan, are their any books you would recommend for a 10,000 ft view of modern accounting principals? 

[Sunrider]

Gio, you may want to spend time looking into the mechanics of OCI ..... very revealing.

 

 

Regulatory capital is simply MV x a risk weight reflecting how risky the asset is; a high risk bond or equity results in zero regulatory capital as it has zero value if it has to be sold today - under adverse conditions; conversely the T-Bill results in 95-100% regulatory capital. The bigger your business (by total assets) & the riskier those assets, the more capital you require in various forms of either equity or CoCo bond. For a given amount of capital you either increase or decrease your business according to how risky your underlying assets are (if risk rises you either recall loans, or cut off the poor credits); if you cannot adjust quickly enough you either put up more capital (billion dollar capital raises), or discontinue lines of business (thereby earning less income & reducing share price). Again, nobody loves the accountability or discipline.

 

 

 

SD

 

Not sure if you're speaking loosely or if you have your facts wrong:

 

Reg Capital REQUIREMENT = Exposure (or value) x Risk weight x Jurisdiction specific minimum %

Reg Capital (call it supply) = instrument value x weight (think common equity weight = 100%)

 

... very roughly speaking. So in that sense your statement that a high risk bond = low capital is wrong. Firstly, any bond would not be counted as capital (it's no form of equity). Secondly, a high risk bond would get a pretty high risk weight attached to it.

 

Anyone who is interested:

If you go to BIS.org you can download the Basel 2 and 3 capital accords, the respective risk weight tables are somewhere in the section for the standardised approach.

 

Cheers - C.

[giofranchi]

Hi Gio

 

I would classify the TD piece as sensationalism to generate web traffic. Nothing more. All the banks are in the same boat - if you mark to market very large security portfolios that are sensitive to interest rate movements you'll see huge P&L volatility. It's helpful to remember that accounting rules are made for all firms, not just banks, and whilst MTM is economically sensible, it may lead to undesirable results for some businesses. By undesirable I mean that accountants actually do not want to estimate economic truth as such (or at least, originally that was less of an objective). You can also see that in provisioning rules that originally allowed more of an expected loss approach, then migrated to an incurred loss approach, and are now moving back to an expected loss approach under IFRS9 (forget what the equivalent US standard is called). It's easy to say that we'd like to have financial statements that reflect economic reality at the point of the statement but if you think about the complexities that need to be considered when estimating the value of illiquid instruments you can see why accountants have stepped back a bit from this.

 

So instead of reporting the swing in income it got moved into the OCI line (below the profit line, so to speak). You still have an effect on equity and you can still estimate economic reality, but you've taken the volatility out of the income line. Big gain? Don't know.

 

More importantly, and this is where I see this as sensationalism, it's not the swing you should be concerned with as such, but the quality of the underlying assets. The negative MTM from an increase in interest rates will amortise out over time as the securities approach maturity. As long as there is no default shareholders are no worse of over the full tenor of the portfolio. So the question I ask myself as a bank shareholder - am I happy with the interim volatility and do I believe the portfolio of securities is ultimately good enough quality?

 

One more thing - if you assume no defaults, wealth has actually been created (but that creation in terms of BV accretion) has been masked by the negative MTM.

 

Cheers - C.

 

Sunrider,

yours is a very good explanation! Thank you very much! :)

But, please, tell me: when you have total assets that are $2 trillion and 10 times equity, how could you really be sure about your judgment of their quality? And you must be sure practically about all of them! Because they are so much larger than your capital.

In the case you are not sure, you are left only with the assumption (hope?) they won’t default. Do I understand this correctly? I ask, because I am well aware it is not my game!

 

giofranchi

 

[ERICOPOLY]

Hi Gio

 

I would classify the TD piece as sensationalism to generate web traffic. Nothing more. All the banks are in the same boat - if you mark to market very large security portfolios that are sensitive to interest rate movements you'll see huge P&L volatility. It's helpful to remember that accounting rules are made for all firms, not just banks, and whilst MTM is economically sensible, it may lead to undesirable results for some businesses. By undesirable I mean that accountants actually do not want to estimate economic truth as such (or at least, originally that was less of an objective). You can also see that in provisioning rules that originally allowed more of an expected loss approach, then migrated to an incurred loss approach, and are now moving back to an expected loss approach under IFRS9 (forget what the equivalent US standard is called). It's easy to say that we'd like to have financial statements that reflect economic reality at the point of the statement but if you think about the complexities that need to be considered when estimating the value of illiquid instruments you can see why accountants have stepped back a bit from this.

 

So instead of reporting the swing in income it got moved into the OCI line (below the profit line, so to speak). You still have an effect on equity and you can still estimate economic reality, but you've taken the volatility out of the income line. Big gain? Don't know.

 

More importantly, and this is where I see this as sensationalism, it's not the swing you should be concerned with as such, but the quality of the underlying assets. The negative MTM from an increase in interest rates will amortise out over time as the securities approach maturity. As long as there is no default shareholders are no worse of over the full tenor of the portfolio. So the question I ask myself as a bank shareholder - am I happy with the interim volatility and do I believe the portfolio of securities is ultimately good enough quality?

 

One more thing - if you assume no defaults, wealth has actually been created (but that creation in terms of BV accretion) has been masked by the negative MTM.

 

Cheers - C.

 

Sunrider,

yours is a very good explanation! Thank you very much! :)

But, please, tell me: when you have total assets that are $2 trillion and 10 times equity, how could you really be sure about your judgment of their quality? And you must be sure practically about all of them! Because they are so much larger than your capital.

In the case you are not sure, you are left only with the assumption (hope?) they won’t default. Do I understand this correctly? I ask, because I am well aware it is not my game!

 

giofranchi

 

Some of those assets are cash.  How can I be certain of it's quality?

Ditto for govt bonds...

 

Then there are mortgages secured by real estate...

 

etc...

 

So while it makes good copy to say 10x exposure to equity, it's meaningless unless you adjust for the low-risk and non-risk assets.

[giofranchi]

How can I be certain of it's quality?

 

Well, of course imo you cannot!

All you might try to guess is the quality of the management who chooses those assets… But this way we go back to my game: owner-operators! ;)

 

giofranchi