BAC-WT - Bank of America Warrants

[Sunrider]

Hi Gio

 

Remember that it's only part of the $2tn assets we're talking about here - only the portfolio that's held/available for sale/trading is being MTM'd. I don't have the figures to hand but I can guarantee that it's much smaller than even $1tn! Also, it's important to remember that the banks have (presumably) learned something and aren't too keen to have another issue because they invested in things that are defaulting (dodgy mortgage bonds) so I'd expect most of the portfolio of bonds and other instruments sensitive to the rate cycle to be of fairly good quality, with a large percentage pertaining to government exposure. Remember, the banks have these portfolios partially for trading and because they intend to make money off the trading but also partially because they need to invest their excess cash somewhere at rates higher than the fee bps the Fed would pay them for overnight deposits.

 

Actually, just looking at the supplement quickly - trading account assets was 191bn. Now some of that will not be interest rate sensitive. Debt securities carried at fair value (where I'd expect most of the IR sensitivity to sit) was 281bn. Assuming that's correct then we saw a 4.2bn swing on 281bn = roughly 1.49% based on an approximately 0.6% increase in LT rates. That gives a DV01 (think delta) of about 70m - i.e. a 70m MTM loss for each 1bps uptick (this is very rough since we're working of the period end balance).

 

Cheers - C.

 

 

 

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

[SharperDingaan]

We'll post more detail over the next day or so. Point form.

- We're referencing within the OSFI context - CAR Guideline. Complies with BIS requirements

- CoCo bonds are Tier 2 Additional Regulatory Capital. Equity if they automatically convert to common.

- Required minimum 'all-in' regulatory capital is 8% of risk weighted assets. Rises through to 2016

- Junk bonds risk rate at 100% of MV. You want it, put up 8% of the MV in regulatory capital

 

Simplified mechanics.

 

A $1M junk bond with a MV of 400K will require 400K x 100% Risk Weight (junk status) & the minimum 2013 8% capital requirement; ie: the bank must put 32K in Regulatory Capital if its going to hold it. Assume the bank cannot actually sell the bond (no market, restrictive covenants, etc).

 

Assume the bond issuer now gets some refinancing; the MV of the bond increases to 600K & the better credit rating reduces the Risk Weight to 50%. The regulatory capital requirement to hold this bond drops to 24K (600K x 50% x 8%). You get back 8K (32-24) from your existing regulatory capital - to grow your business through fresh loans; the alternative was a capital raise for 8K.

 

This is VERY simple, & strictly to illustrate. Changing the AFS designation, changing regulatory capital requirements (by year), & liquidity valuation haircuts (delayed for 2 yrs), add additional complexity. The more your junk resembles plain vanilla the better you do - the more exotic (ie: GS variety) it is the greater the odds that liquidity discounts will negate the benefit. 

 

SD

 

 

 

 

[jay21]

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.

 

This also ignores the best part of being a bank.  The deposits!  If you have sticky deposits, its almost like having equity.

 

As it Eric points out, if cash, treasuries, and agencies default, I probably have bigger problems than my investment in a bank.  The biggest risk with banks is when securities that are rated AAA have the credit quality of less than B and you have a lot of ST funding financing them.  That's when the business model breaks down.

[giofranchi]

This is VERY simple, & strictly to illustrate. 

 

Ahahahahahahahahahahahah!!!!!

 

I must be the dumbest person living on earth! Because I understand 1 out of 10 things that you write! And I say 1, becuase I am too ashamed to admit it really is 0.5!! ;D ;D ;D

 

giofranchi

[ERICOPOLY]

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.

 

This also ignores the best part of being a bank.  The deposits!  If you have sticky deposits, its almost like having equity.

 

As it Eric points out, if cash, treasuries, and agencies default, I probably have bigger problems than my investment in a bank.  The biggest risk with banks is when securities that are rated AAA have the credit quality of less than B and you have a lot of ST funding financing them.  That's when the business model breaks down.

 

Deposits also don't cut you the way insurance float can cut you.

 

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can.  In fact, aren't they investments? 

 

So you bring in a dollar of premiums and invest it two ways:

1)  a bond (investment)

2)  a policy (a second liability) that costs you money when the wind blows, the earth shakes, etc...

 

But it's only counted once.

 

Second point to make... once again regarding this 10x leverage of the bank.  There is a loan loss reserve that isn't counted as part of that equity -- or were you counting it?

[giofranchi]

If you have sticky deposits, its almost like having equity.

 

Isn’t this like saying that float gathered at an underwriting profit is almost like equity? ???

 

giofranchi

[xazp]

Zero Hedge is the National Enquirer of the financial world.  It spreads so much misinformation and half-truths.  The people who follow it since 2009 have probably lots tons of money (which indirectly has been handed to me, so, awesome). 

 

I don't even know where to start with that article, they're mixing up so many issues.  I did appreciate the picture of Brian riding a Unicorn though.  He usually looks so serious!

 

For example the bonds they are referring to ARE marked to market (not to "unicorn").  That is why book value declined in the past quarter.  The accounting is above-board, correct, and exactly what should happen. 

 

Put it this way: over the past several years, interest rates have dropped from 8% to 1.6%.  Banks never booked a dime of earnings as their bonds rose in value.  And Zero Hedge never complained they were "under-estimating earnings."  Then, interest rates go from 1.6% to 2.5% and all of a sudden the banks are cheating earnings?  LOL come on. 

 

 

 

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

[giofranchi]

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right? But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

[ERICOPOLY]

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right?

 

giofranchi

 

That is how it works out, yes.

 

Don't you remember in 2005 when Montpelier Re (MRH) lost 70% of shareholder equity in one quarter?  I mean, holy shit!

 

And they were underwriting at a profit for the years leading up to that event.

[giofranchi]

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right?

 

giofranchi

 

That is how it works out, yes.

 

Don't you remember in 2005 when Montpelier Re (MRH) lost 70% of shareholder equity in one quarter?  I mean, holy shit!

 

And they were underwriting at a profit for the years leading up to that event.

 

For what I know history is full of runs on banks also!!

 

giofranchi

[ERICOPOLY]

But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Sure, as long as you call it "equity" when Wells Fargo takes in a deposit and loans it out -- because year after year they make a profit from that.

 

I don't think Tyler Durden would call the loan portfolio "equity".

[giofranchi]

But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Sure, as long as you call it "equity" when Wells Fargo takes in a deposit and loans it out -- because year after year they make a profit from that.

 

I don't think Tyler Durden would call the loan portfolio "equity".

 

I don't know how Tyler Durden would call what... and I don't care!

 

I call what I own EQUITY, and what I owe LIABILITIES. Until now it has worked well enough! ;D

 

giofranchi

[jay21]

If you have sticky deposits, its almost like having equity.

 

Isn’t this like saying that float gathered at an underwriting profit is almost like equity? ???

 

giofranchi

 

No, imo, they are quite different.  Float places a lot more strain on an entity than deposits.  You will have to pay out the majority of your reserves over time.  For sticky deposits, this is not the case.  Also, the potential for changes in insurance liabilities makes it a lot different as Eric mentioned.

 

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right? But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Not necessarily.  You can book a 90 CR and then have a cat loss and revise to a 99 CR.  It was profitable underwriting, but the readjustment probably hurt you.

[ERICOPOLY]

But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Sure, as long as you call it "equity" when Wells Fargo takes in a deposit and loans it out -- because year after year they make a profit from that.

 

I don't think Tyler Durden would call the loan portfolio "equity".

 

I don't know how Tyler Durden would call what... and I don't care!

 

I call what I own EQUITY, and what I owe LIABILITIES. Until now it has worked well enough! ;D

 

giofranchi

 

Fair enough.  I was misled by your spending time on what Tyler Durden says.

[giofranchi]

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right? But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Not necessarily.  You can book a 90 CR and then have a cat loss and revise to a 99 CR.  It was profitable underwriting, but the readjustment probably hurt you.

 

Well, jay, mine was a rhetorical question… of course you won’t compare that to equity… because it is not equity… exactly like deposits are not equity… even sticky deposits… in a deflationary scare or financial panic withdrawals will always hurt banks… the same way unexpected cat losses would hurt insurance companies… that’s why you should always be careful not to rely too much on what you don’t own, any form it takes!

 

giofranchi

 

[jay21]

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right? But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Not necessarily.  You can book a 90 CR and then have a cat loss and revise to a 99 CR.  It was profitable underwriting, but the readjustment probably hurt you.

 

Well, jay, mine was a rhetorical question… of course you won’t compare that to equity… because it is not equity… exactly like deposits are not equity… even sticky deposits… in a deflationary scare or financial panic withdrawals will always hurt banks… the same way unexpected cat losses would hurt insurance companies… that’s why you should always be careful not to rely too much on what you don’t own, any form it takes!

 

giofranchi

 

If people are withdrawing, then they are not sticky.  The best deposit franchises have increased their deposits during this deflationary time.

[xazp]

There was a recent financial panic.  The results were: depositors moved money from small banks to large banks.

 

Since then, regulators have insisted that large banks hold more capital, liquidity, etc than small banks.  So, during times of stress, I once again expect depositors to flock to large banks. 

 

 

 

 

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right? But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Not necessarily.  You can book a 90 CR and then have a cat loss and revise to a 99 CR.  It was profitable underwriting, but the readjustment probably hurt you.

 

Well, jay, mine was a rhetorical question… of course you won’t compare that to equity… because it is not equity… exactly like deposits are not equity… even sticky deposits… in a deflationary scare or financial panic withdrawals will always hurt banks… the same way unexpected cat losses would hurt insurance companies… that’s why you should always be careful not to rely too much on what you don’t own, any form it takes!

 

giofranchi

[ERICOPOLY]

There was a recent financial panic.  The results were: depositors moved money from small banks to large banks.

 

Since then, regulators have insisted that large banks hold more capital, liquidity, etc than small banks.  So, during times of stress, I once again expect depositors to flock to large banks. 

 

 

 

 

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right? But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Not necessarily.  You can book a 90 CR and then have a cat loss and revise to a 99 CR.  It was profitable underwriting, but the readjustment probably hurt you.

 

Well, jay, mine was a rhetorical question… of course you won’t compare that to equity… because it is not equity… exactly like deposits are not equity… even sticky deposits… in a deflationary scare or financial panic withdrawals will always hurt banks… the same way unexpected cat losses would hurt insurance companies… that’s why you should always be careful not to rely too much on what you don’t own, any form it takes!

 

giofranchi

 

Additionally,

 

A very large bank doesn't have a large percentage of it's risky assets tied to a small geographic area.

 

I read that Australia requires small banks to carry more capital than large banks for this common-sense reason.

[wescobrk]

Obviously there is more upside to go, but just curious if anyone wants to share if they are reducing any concentration in BAC (selling) but still own quite a bit?

[berkshiremystery]

Obviously there is more upside to go, but just curious if anyone wants to share if they are reducing any concentration in BAC (selling) but still own quite a bit?

 

My gut feeling had expected days ago this strong upward move. I go take a nape and stay calm. ;)

[LC]

Not sure! M options are up something like 90%...and as I'm relatively new to this game it is one of my largest gains (percentage and absolute-wise) yet. So I am going to think it over today and ultimately give it the "can I sleep comfortably" test!

[Parsad]

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

 

You would be correct here Gio!  The only thing I can say is that there is so much oversight on bank capital and quality, that there probably is pretty good judgment by the regulators from that perspective.  Any leveraged institution is risky, but I would say the U.S. banks after all of the recapitalization, oversight, reduction in risky assets and debt, could not be in much better position.  We do not know the quality of all of the underlying assets, but from a rational view, they must be multiples better today than in 2007!  Cheers!

[nkp007]

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

 

You would be correct here Gio!  The only thing I can say is that there is so much oversight on bank capital and quality, that there probably is pretty good judgment by the regulators from that perspective.  Any leveraged institution is risky, but I would say the U.S. banks after all of the recapitalization, oversight, reduction in risky assets and debt, could not be in much better position.  We do not know the quality of all of the underlying assets, but from a rational view, they must be multiples better today than in 2007!  Cheers!

 

Bingo!

[txlaw]

Obviously there is more upside to go, but just curious if anyone wants to share if they are reducing any concentration in BAC (selling) but still own quite a bit?

 

I've been reducing my exposure to BAC and increasing my exposure to JPM.

[giofranchi]

Taking an insurer and saying it's 3x levered is sort of misleading -- major cat losses can hurt just like investments can. 

 

Well, that would be float gathered at an underwriting loss, right? But what if year after year you have gathered it at an underwriting profit? Would you compare that to equity?

 

giofranchi

 

Not necessarily.  You can book a 90 CR and then have a cat loss and revise to a 99 CR.  It was profitable underwriting, but the readjustment probably hurt you.

 

Well, jay, mine was a rhetorical question… of course you won’t compare that to equity… because it is not equity… exactly like deposits are not equity… even sticky deposits… in a deflationary scare or financial panic withdrawals will always hurt banks… the same way unexpected cat losses would hurt insurance companies… that’s why you should always be careful not to rely too much on what you don’t own, any form it takes!

 

giofranchi

 

If people are withdrawing, then they are not sticky.  The best deposit franchises have increased their deposits during this deflationary time.

 

Jay, all I am saying is that sticky deposits are not equity...

Equity = 1

Sticky deposits = 9

Debt = 0

Total assets = 10

If you do something stupid and your assets decrease 10% in value, you are bankrupt no matter how sticky deposits are.

Don't you agree? 

 

giofranchi