BAC-WT - Bank of America Warrants

[ERICOPOLY]

A year ago today the B warrant closed at 77 cents.

Today the B warrant closed at 78 cents.

[racemize]

A year ago today the B warrant closed at 77 cents.

Today the B warrant closed at 78 cents.

 

I wonder how long it will keep that up.  Any speculations Eric?  At some point, those have to be interesting, but 18% cost of leverage is pretty steep (and that's ignoring the dividend increase from 0.01->0.32, or at least whatever potion it ends up being by 2018).

[ERICOPOLY]

A year ago today the B warrant closed at 77 cents.

Today the B warrant closed at 78 cents.

 

I wonder how long it will keep that up.  Any speculations Eric?  At some point, those have to be interesting, but 18% cost of leverage is pretty steep (and that's ignoring the dividend increase from 0.01->0.32, or at least whatever potion it ends up being by 2018).

 

The funny thing about that one though is that BofA could deliver on cost cuts and business discipline just like we hope and yet the B warrant still might wind up being worthless at expiry given the high strike price (which might be a $27 strike after dividend adjustments).  For example, the stock could be $33 a month before expiration, then suddenly it could drop to $27 in a generalized market crash and you are wiped out.  And $27 would still be a premium to tangible book.  So it's not like there is a lack of precedent here.

 

It expires in October 2018 -- just 5 years left.  Today the tangible book is roughly 13.5.

 

So my thinking is that as long as you are up for playing a game of chicken that the stock will trade at a premium to tangible book around expiry.... then just play that game today with the 2015 LEAPS.  At least you won't have to wait as long to find out if you are wiped out or not  :)

[ERICOPOLY]

Actually, I wouldn't touch a B warrant with a 10 foot pole.

 

Today's TBV is 13.60 maybe.  If they retain $1.28 per share on average for next 5 years (until expiry), then TBV is $20 in 2018.

 

Then at 1.2x TBV the stock is only $26.  That puts a big ZERO on the warrants.

 

Sure, the future might be better than I laid out -- but my scenario is perfectly reasonable.  Too risky for me.

 

[Parsad]

Actually, I wouldn't touch a B warrant with a 10 foot pole.

 

Today's TBV is 13.60 maybe.  If they retain $1.28 per share on average for next 5 years (until expiry), then TBV is $20 in 2018.

 

Then at 1.2x TBV the stock is only $26.  That puts a big ZERO on the warrants.

 

Sure, the future might be better than I laid out -- but my scenario is perfectly reasonable.  Too risky for me.

 

Yeah, I would totally agree with Eric.  TBV may be slightly higher if they do better, but that would have no effect on your "B" warrants. 

 

While you should make a decent return on the "A's", it still won't be fantastic if you are buying them for just above $6, exercise is at $13.30 or so, and stock is at $26-$28 in 2018-2019.  Cheers!

[ERICOPOLY]

The lowest closing price yet for the B warrants was 29 cents on Dec 19, 2011.  On that day the common closed at $4.99.

 

The B warrants are up 169%.

The common is up 181%.

 

The highest closing price for the B warrants was $4.85 on April 12, 2010.

On that day the common closed at $18.39.

 

But I remember fellow board member twacowfa bought the B warrants at the bottom and sold them for a huge gain in Feb/March 2012.

 

It's been tough sledding for the B warrants.

[Parsad]

Actually, I wouldn't touch a B warrant with a 10 foot pole.

 

Today's TBV is 13.60 maybe.  If they retain $1.28 per share on average for next 5 years (until expiry), then TBV is $20 in 2018.

 

Then at 1.2x TBV the stock is only $26.  That puts a big ZERO on the warrants.

 

Sure, the future might be better than I laid out -- but my scenario is perfectly reasonable.  Too risky for me.

 

Yeah, I would totally agree with Eric.  TBV may be slightly higher if they do better, but that would have no effect on your "B" warrants. 

 

While you should make a decent return on the "A's", it still won't be fantastic if you are buying them for just above $6, exercise is at $13.30 or so, and stock is at $26-$28 in 2018-2019.  Cheers!

 

Albeit, we are talking about tangible book, not book.  The assumption is that in the worst case scenario, much of the difference is utilized during runoff of legacy issues. 

 

If you assume that book will continue to grow, and that legacy issues will diminish without utilizing that difference, then the "A's" could still provide good value.  But the huge margin that was available a couple of years ago is no longer there.  Cheers!

[ERICOPOLY]

I wonder what kind of thinking supports/drives the pricing in the B warrants.

 

You could buy the common today at $14, write a 2015 $22 strike call for 20 cents,  then purchase a B warrant for 78 cents.  You would be 58 cents into margin debt (only 4% margin).

 

If the stock shoots up above $22 by expiry, and your shares get called, you've got $22 a share -- and you miss out on any further gains before the stock reaches the warrant strike. 

 

But you then have 3.75 years left to grow your $22 dollars.  If you can grow it higher than the warrant strike by warrant expiration, you make bonus money.  I believe that would probably happen with a high single digit return.

 

But if instead the $22 strike call expires worthless (maybe the stock is only $17), you can then write another call for perhaps 20 cents and maybe $25 strike.  Or maybe instead you give up on that game and instead sell the B warrants for 78 cents (or more).

 

Etc... Etc...

 

But after perhaps only 2 or 3 years of this game you've completely paid off the cost of the B warrants.  Thus, it becomes a free ride after than.  Worst case (for the first iteration), you get called on the first round of this game at $22 -- and only have to grow it at a high single digit pace after that to keep up with the stock reaching the warrant strike.

[Uccmal]

"b" warrants seem way overpriced on an intuitive basis.  To make 15% per year to expiry you need the stock price to reach $36-37 by expiry. Or you need huge dividend increase and buybacks to bring down the strike.  So far, we have no evidence of BAC being in a hurry to do either.  Never mind the random effects that Eric discussed. 

 

36-37 per share works out to a market cap around 450 B.  For context Apple has 150"B cash and a market cap of 430 B.  XOM has a market cap of 380 B.  BAC isn't yet an Apple or an XOM cash machine. 

 

The price of the B-warrants looks to be determined by computer models and has not been rationally analyzed by a human being.  It should really be a few cents since it is more like a lottery ticket. 

[ERICOPOLY]

"b" warrants seem way overpriced on an intuitive basis.  To make 15% per year to expiry you need the stock price to reach $36-37 by expiry.

 

Not quite that much.  The warrant strike is a bit under $31 and the warrants are 78 cents.  15% for 5 years would put them at $1.57 per B warrant.

[wescobrk]

36-37 per share works out to a market cap around 450 B.  For context Apple has 150"B cash and a market"

 

I don't understand your math.

They would have to have 12.1 billion shares outstanding to equal 450 market cap at 37.

It'll probably be 3-5 years to get close to 37 a share.

They are buying back at least 5 billion a year and today they have around 11 billion shares also warren may accept a lower amount of shares like Goldman so he doesn't have to pay any money to get the warrants.

 

I think at 37 a share a more accurate market cap is closer to 370 billion and not 450.

[ERICOPOLY]

So all of these ideas on where the stock price may trade rests on an assumption of price multiple to earnings.

 

I can see (very optimistically) $2 a share a year from today, but if I grow it at 6% a year after that for 4 years I get a $2.50 per share earnings when the B warrants expire in Oct 2018.

 

10x earnings:  $25

11x earnings:  $27.50

12x earnings: $30

13x earnings:  $32.50

14x earnings: $35

15x earnings: $37.50

 

Obviously the market multiple to earnings is critical.  What would the right multiple be?  About 12x?

 

[Uccmal]

Wescobrk, Eric, I will concede a bit on the math, which I did in about 3 minutes.

 

Using Eric's number to get 15%: the final stock price needed will be 32.57 x 10.7 B shares = 350 B. 

 

That is still a very rich total market cap.  It implies:

 

1) that buy backs exceed issuances of shares - I have yet to see it.  10 b of common buybacks is only 500 m shares at &20.00.  Can that be sustained without dilution via issuances.

 

and/or 2) that dividends increase enough to take down the strike price - more plausible but does it support 0.78 per share for the "b"s?

 

2) that there isn't a wild card event that wipes out the value of the B's completely within the last year, or even two years.  It only has to be below 31.78 per share to lose everything. 

This is where I see by far the most danger.  It could be an event totally unrelated to BAC. 

 

I would want to be compensated for the risk.  On a mathematical basis is looks like you are being compensated.  In reality the models aren't accounting for a wild card event at all. 

 

Just to understand where I am coming from I have 2015 Leaps, obviously all bought sometime in the past year:  The $10 ones are up 78%; the $12s are up 43%.  I purchased them along the way from 9 to around $12.00.  I have sold a few at lower and higher prices along the way.  In general, If I am going to use Leaps I want those kinds of returns to compensate for a total bust.  I dont set a number at the outset but my thinking is big returns. 

 

I also doubt my ability to hold such a volatile security for the full 5 years. 

 

I tend to think that BACs stock price will rise faster in the next couple of years, rather than in the last 3 or so of the 5 years.  For a savvy trader the b's may have value but that is playing on the greater fool theory. 

 

The reason I think the stock will rise faster at first is several fold:

1) Benefits from cost savings will not increase much after the next year or two.  They will begin to have to hire to grow.

2) Benefits from NOLs will cease.

3) Litigation costs will stabilize at a certain run rate.

4) Banks elsewhere will be in full recovery mode, providing greater competition. 

 

I dont think a $33 stock price is totally out to lunch by any means.  I just think that the b's are not being compensated for a total bust.  The models being used dont account for that possibility.

 

 

[racemize]

So regarding the volatility concerns--I would presume someone would just exercise or sell the b's once they got up in the 35 range. Are you worried that it gets close, but not all the way there and then drops back down?

 

I guess asking it another way, this big drop concern applies to the leaps just as we'll, doesn't it?

 

I agree regarding the closeness of price appreciation--hopefully, it does work out that way for all of us.

[ERICOPOLY]

I guess asking it another way, this big drop concern applies to the leaps just as we'll, doesn't it?

 

That's why I wrote yesterday that if one wants to take a gamble that a macro event won't happen near expiration, then why not go with LEAPS instead.  Just face your fear  ;)

 

 

[ERICOPOLY]

$2 a share earnings power a year from now (optimistically), multiplied by 11.5b fully diluted shares, and you have $23 billion net income.

 

At 15x earnings it's a $350 billion company. 

 

15x is probably too rich.

 

But it's a $400 billion company at that 15x earnings multiple in Oct 2018 if earnings grow at 3.5% per year for the remaining 4 years.

 

So personally I wouldn't compare it to Apple or Exxon.  I would just ask what they can earn per share, and ask what a reasonable earnings multiple would be.

 

IMO if $400 billion is too rich it's not because of the large absolute number, it's because of the large multiple to earnings (15x). 

 

I don't think it matters if you are the largest market cap company -- as long as you have the earnings to support it and the earnings multiple is reasonable.  BAC has over a trillion in deposits -- suppose they only had $100 billion in deposits, people would be arguing that trillion isn't even conceivable.  But there it is, they have a trillion -- likewise, they're going to be a very large market cap company because with that very large deposit base will come very large earnings.

[Uccmal]

Racemize, When one is pushing out to the fringes which is where these warrants are priced there is alot that can go wrong - both inside and outside BAC - just ask Jamie Dimon.  We know BM is risk adverse but what about his successor if he leaves before the strike date.  Does BM really know the entirety of the risk profile in his organization? 

 

Eric, I think you are misunderstanding my using Apple and XOM as examples.  Sure BAC could trade as high as XOM in total market cap.  No argument from me.  But both Apple and XOM, and other mega caps tend to trade at lower pe ratios than smaller companies.  I see no reason when the BAC recovery is complete that it should be an exception. 

 

Fudging the numbers slightly lower than ideal:

So give it 28 B earnings X 11 pe /10 B shares = $31 = worthless  B warrants

 

I think its a long shot due to the requirement for near perfect execution, market conditions, and possible whale events at some point near the strike date. 

[ERICOPOLY]

Eric, I think you are misunderstanding my using Apple and XOM as examples.  Sure BAC could trade as high as XOM in total market cap.  No argument from me.  But both Apple and XOM, and other mega caps tend to trade at lower pe ratios than smaller companies.  I see no reason when the BAC recovery is complete that it should be an exception. 

 

That's the reason why I think 15x is too rich.  I'm wondering if 12x is feasible.  The company won't be able to grow faster than GDP I figure.  12x earnings multiple would give an investor a 10% return if bank has 2% nominal growth tailwind from GDP.

[wescobrk]

Actually, I wouldn't touch a B warrant with a 10 foot pole.

 

Today's TBV is 13.60 maybe.  If they retain $1.28 per share on average for next 5 years (until expiry), then TBV is $20 in 2018.

 

Then at 1.2x TBV the stock is only $26.  That puts a big ZERO on the warrants.

 

Sure, the future might be better than I laid out -- but my scenario is perfectly reasonable.  Too risky for me."

 

I believe Jpm has been earning close to 17 % tbv (15-17), in q2 bac earned 9.6% on tbv.

They still have about 1.8 billion per quarter from las to get to 500 million per management by 2015.

I don't see why bac can't get tbv returns of mid to high teens over next couple of years. They also still have more expenses to lower and interest rates normalizing will ultimately help as well.

Certainly we will have another recession within next few years and lots of volatility but I think mid to high teens tbv return a 1.5 multiple on tangible book is very reasonable and probably a bit conservative.

I definitely agree they can't grow faster than nominal GDP but, over time, I think 1.5-1.7 tbv isn't overly optimistic.

 

[ERICOPOLY]

I definitely agree they can't grow faster than nominal GDP but, over time, I think 1.5-1.7 tbv isn't overly optimistic.

 

Towards the end of 2012 Moynihan thought 13% to 15% returns on TBV by mid-2015 was a reasonable target.  That was assuming interest rates showed no improvement.

 

I figure if a P/E of 10x is assumed, then that would translate to 1.3x to 1.5x TBV.  Or 1.43x to 1.65x TBV at 11x P/E.

 

But when I said 1.2x above, I was still working off the idea that the markets could be in the toilet for whatever reason (recession perhaps).  That would be very inconvenient for the B warrants, but I suppose you could treat them like any other LEAPS towards the end of 2017 and roll them to a 2020 strike LEAPS call.  No reason to let them run out the clock so close to expiration.

[Uccmal]

 

But when I said 1.2x above, I was still working off the idea that the markets could be in the toilet for whatever reason (recession perhaps).  That would be very inconvenient for the B warrants, but I suppose you could treat them like any other LEAPS towards the end of 2017 and roll them to a 2020 strike LEAPS call.  No reason to let them run out the clock so close to expiration.

 

I guess that begs the question... Why bother.  I like my Leaps to have strikes well within the realm of present day reality.  My highest strike BAC Leap is the $15.  When the 2016s come out I will be willing to go up to $20.00.  Unfortunately, they come out after the earnings date/or perhaps fortunately!

[ECCO]

 

But when I said 1.2x above, I was still working off the idea that the markets could be in the toilet for whatever reason (recession perhaps).  That would be very inconvenient for the B warrants, but I suppose you could treat them like any other LEAPS towards the end of 2017 and roll them to a 2020 strike LEAPS call.  No reason to let them run out the clock so close to expiration.

 

I guess that begs the question... Why bother.  I like my Leaps to have strikes well within the realm of present day reality.  My highest strike BAC Leap is the $15.  When the 2016s come out I will be willing to go up to $20.00. Unfortunately, they come out after the earnings date/or perhaps fortunately!

 

Bank of America Corporation today announced it will report its third-quarter 2013 financial results on Wednesday, October 16, 2013. The results are scheduled to be released at 7 a.m. ET, followed by an investor presentation at 8:30 a.m. ET.

 

BAC is in option cycle #2 so 2016 leaps will be available monday october 14.

 

So you have 2 days to switch your options before result are released.

[ERICOPOLY]

The analysts estimated 25 cents for Q2 earnings, then the bank actually reported 32 cents. 

 

In what area(s) of the business were they taken by surprise?

 

[Uccmal]

 

But when I said 1.2x above, I was still working off the idea that the markets could be in the toilet for whatever reason (recession perhaps).  That would be very inconvenient for the B warrants, but I suppose you could treat them like any other LEAPS towards the end of 2017 and roll them to a 2020 strike LEAPS call.  No reason to let them run out the clock so close to expiration.

 

I guess that begs the question... Why bother.  I like my Leaps to have strikes well within the realm of present day reality.  My highest strike BAC Leap is the $15.  When the 2016s come out I will be willing to go up to $20.00. Unfortunately, they come out after the earnings date/or perhaps fortunately!

 

Bank of America Corporation today announced it will report its third-quarter 2013 financial results on Wednesday, October 16, 2013. The results are scheduled to be released at 7 a.m. ET, followed by an investor presentation at 8:30 a.m. ET.

 

BAC is in option cycle #2 so 2016 leaps will be available monday october 14.

 

So you have 2 days to switch your options before result are released.

 

Hmm, I have it in my Calender as Oct. 21st. Anyway, with the debt ceiling as a back drop I am not doing anything at the moment.  Things could well go alot cheaper. 

[gary17]

I am a bit surprised that the two European banks I have been following, one which I own, NBG and IRE are both up the last few days while BAC, WFC and other US banks have been falling a bit.

 

I would have thought the risk of default is not limited to the US. Why does the market not to seem to factor that in?