BAC-WT - Bank of America Warrants

[ERICOPOLY]

I saw you used 11.5 billion  for shares. I'm assuming that will be south of 11 billion fully Diluted by then but it must be the nim plus share buybacks to get us to 50 cents a quarter by q2 of 2015.

 

I know, but I also didn't give any of their employees a raise -- compensation expenses are probably going to climb of course.  So that will eat up some of what you expect to gain from share count reduction.

 

Then they plan to reduce LT debt by $20b next year.  And maybe they'll retire $10b in preferred.

 

Their mortgage origination business (not counting refinancing) is very small relative to peers -- they can grow it.  It grew 15% this past year.

 

They just have a lot of rebuilding left.

 

Plus, they'll probably cut the corporate tax rate down to 28% at least -- it can't stay at 35% anymore.  I mean, we should never have separated from Great Britain in the first place... over taxes!  How ironic is that?  They've agreed to take theirs down to 20%.  A 7% reduction would boost earnings by 15 cents a year, roughly.

[jay21]

They provisioned $300m for credit losses in Q3 and earned 28 cents a share.  Somewhere I saw it suggested that about $1.5b would be the normalized quarterly provisioning.

 

That's $1.2b that effectively padded earnings.  At 35% tax rate, about 6.8 cents per share.

 

They are over reserved still.  The reason they are able to "pad earnings" is because their balance sheet is conservative.  Given where their reserves are at, I think they could not reserve anything for the next year, which would inflate earnings.

 

Also, I am not going so far in depth on this as you in terms of earnings modelling (although I am weighted more towards equity so getting the earnings in the next two years right does not matter as much to me compared to if I was invested in calls).  But when I look at where their reserves are, where their capital levels are, where their efficiency ratio is, etc.  they are clearly under-utilizing their asset base.  They should be able to get numbers above 1% ROA and potentially closer to their peers, JPM and WFC.

 

[wescobrk]

"I know, but I also didn't give any of their employees a raise -- compensation expenses are probably going to climb of course.  So that will eat up some of what you expect to gain from share count reduction."

 

Q1 of this year was horrific I think almost a billion in comp expense including stock options.

One good thing about the stock not doing much this year compared to doubling in 2012 at least this figure should be a lot less in q1 of next year.

[ERICOPOLY]

The stock compensation expense...

 

The bank decided at the end of 2011 that they would cut the amount paid to employees in cash, and replace it with stock.  This was explicitly stated to us shareholders as a means of rebuilding the balance sheet.  In those days, they would issue stock at $6 per share (not to Buffett, but to the general market)... good grief.

 

So can't they go back to cash compensation now?

 

[ERICOPOLY]

Anyways, the 10-Q explained that the long end of the curve rose 80 bps during the first 9 months of the year.

 

So if rates rose a further 200 bps steadily over the next 24 months, or even the next 12 months, they should easily handle it if they just keep doing what they did this year.

 

I also found it interesting that they make 3% NIM on their loans and leases when you exclude the impact of their trading operations.  They explain that part of the trading operations is hedging their interest rate risk.

[damianolive]

The attached excel summarizes most of the relevant earnigns drivers working off of 3Q numbers - it's most of the items you're talking about. It includes a first step of cleaning up 3Q numbers (reversing the reserve releases, litigation, UK taxes, etc) and then a second step of more longer term changes (NIM, cost reductions from LAS and New BAC, preferred and LT debt repayment etc). It gets to around $2 in EPS and 13% ROTE by 2015/2016.

BAC_earnings_power.xlsx

[wescobrk]

If every large bank in the us is earning above 1 percent roa and bac is well south of it, at some point the board will be forced to take action and remedy that.

[wescobrk]

"The stock compensation expense...

 

The bank decided at the end of 2011 that they would cut the amount paid to employees in cash, and replace it with stock.  This was explicitly stated to us shareholders as a means of rebuilding the balance sheet.  In those days, they would issue stock at $6 per share (not to Buffett, but to the general market)... good grief.

 

So can't they go back to cash compensation now?"

 

I'm sure they can but I'm also confident  Moynihan won't do it.

He's very poor at capital equity allocation.

It's great having Buffett as a partner but he gave away about 7 percent of the company for it and it shows with employees as well.

His days are numbered I think if we don't get to 2 bucks starting mid 2015 (assuming GDP continues at 2 percent like the last 4 years and doesn't significantly contract)

[wescobrk]

One more post.

Market is trading at about 17x earnings.

Banks are trading around 12x

That 30 percent gap should start to converge at some point as banks eventually earn their cost of capital.

[ERICOPOLY]

So there were $255 million preferred dividends declared in Q3.  That eats up $400 million in pre-tax profits at 35% rate.

 

Okay, so eliminating the $16billion of remaining preferred would leave only $600 million of pre-tax quarterly revenues needed to bring things up to 13% return on tangible equity. 

 

Yes they should be able to do this without much magic.

[ourkid8]

Exactly but let's hope Mr. Moynihan actually requests $20B capital return.  ($10B calling preferred, $7B in share repurchase and $3B in dividends)  If he requests anything less, I would be disapointed.

 

Tks,

S

 

So there were $255 million preferred dividends declared in Q3.  That eats up $400 million in pre-tax profits at 35% rate.

 

Okay, so eliminating the $16billion of remaining preferred would leave only $600 million of pre-tax quarterly revenues needed to bring things up to 13% return on tangible equity. 

 

Yes they should be able to do this without much magic.

[morningstar]

BAC also needs to issue a fair amount of preferreds over the next couple years (something like $8bn assuming no major change in RWAs) to maximize their Additional Tier 1 bucket, so net from today you are probably adding more preferreds than you take out via TruP calls. Unless you want to fill that bucket with common. I'm sure RWAs will shrink but in the end state you probably need $15-16bn in preferreds... which shakes out to about $250m in preferred dividends assuming an average 6.5% coupon. So I don't know the preferred dividend component will be shrinking too much.

[ERICOPOLY]

BAC also needs to issue a fair amount of preferreds over the next couple years (something like $8bn assuming no major change in RWAs) to maximize their Additional Tier 1 bucket, so net from today you are probably adding more preferreds than you take out via TruP calls. Unless you want to fill that bucket with common. I'm sure RWAs will shrink but in the end state you probably need $15-16bn in preferreds... which shakes out to about $250m in preferred dividends assuming an average 6.5% coupon. So I don't know the preferred dividend component will be shrinking too much.

 

I'm in favor of not paying a dividend, instead using the "would be" dividend cash for retirement of all of the preferred stock.

 

Californian BAC shareholders will pay about 33% top rate on dividends.  That leaves only 67 cents on the dollar.

 

The preferred in aggregate yield 7% after-tax (it is paid with after-tax profits that otherwise belong to common shareholders). 

 

So... in terms of after-tax dividend value, calling in preferred stock would give Californian shareholders slightly more than 10% after-tax returns.  And meanwhile, there is the add-on effect of reducing risk to the common stock.

 

I would need to find a corporate bond yielding 18.5% in order to replicate a 10% after-tax return.  (top income rate at 46% paid on bond income is higher than the 33% dividend rate)

[xazp]

I prefer buybacks which in effect are tax-free distributions to shareholders.  If BAC thinks (for example) that normalized earnings are $2/share, they should be buying back aggressively through $20.  Whatever their view of normalized earnings, I think they should buy back below 10x that number, and dividend at over 10x that number.

 

As it pertains to your preference for preferred vs dividend buybacks, I think you are overlooking the capital gains that go along with dividends.  This is mostly investor psychology. 

 

But consider this example.  Say BAC concludes it can sustainably pay out $15Bn in capital each year, and institutes a $15Bn dividend.  It's hard for me to see BAC trading at less than a $300Bn market cap.  From the equity holder's point of view, they would earn $15Bn in dividends, but $150Bn in capital gains.  The bulk of your gains come from people reacting to the dividend, not the actual dividend.  And I think that number would be far greater than paying off $15Bn in preferreds.

 

 

 

BAC also needs to issue a fair amount of preferreds over the next couple years (something like $8bn assuming no major change in RWAs) to maximize their Additional Tier 1 bucket, so net from today you are probably adding more preferreds than you take out via TruP calls. Unless you want to fill that bucket with common. I'm sure RWAs will shrink but in the end state you probably need $15-16bn in preferreds... which shakes out to about $250m in preferred dividends assuming an average 6.5% coupon. So I don't know the preferred dividend component will be shrinking too much.

 

I'm in favor of not paying a dividend, instead using the "would be" dividend cash for retirement of all of the preferred stock.

 

Californian BAC shareholders will pay about 33% top rate on dividends.  That leaves only 67 cents on the dollar.

 

The preferred in aggregate yield 7% after-tax. 

 

So... in terms of after-tax dividend value, calling in preferred stock would give Californian shareholders slightly more than 10% after-tax returns.  And meanwhile, there is the add-on effect of reducing risk to the common stock.

[ERICOPOLY]

I prefer buybacks which in effect are tax-free distributions to shareholders.  If BAC thinks (for example) that normalized earnings are $2/share, they should be buying back aggressively through $20.  Whatever their view of normalized earnings, I think they should buy back below 10x that number, and dividend at over 10x that number.

 

As it pertains to your preference for preferred vs dividend buybacks, I think you are overlooking the capital gains that go along with dividends.  This is mostly investor psychology. 

 

But consider this example.  Say BAC concludes it can sustainably pay out $15Bn in capital each year, and institutes a $15Bn dividend.  It's hard for me to see BAC trading at less than a $300Bn market cap.  From the equity holder's point of view, they would earn $15Bn in dividends, but $150Bn in capital gains.  The bulk of your gains come from people reacting to the dividend, not the actual dividend.  And I think that number would be far greater than paying off $15Bn in preferreds.

 

 

 

BAC also needs to issue a fair amount of preferreds over the next couple years (something like $8bn assuming no major change in RWAs) to maximize their Additional Tier 1 bucket, so net from today you are probably adding more preferreds than you take out via TruP calls. Unless you want to fill that bucket with common. I'm sure RWAs will shrink but in the end state you probably need $15-16bn in preferreds... which shakes out to about $250m in preferred dividends assuming an average 6.5% coupon. So I don't know the preferred dividend component will be shrinking too much.

 

I'm in favor of not paying a dividend, instead using the "would be" dividend cash for retirement of all of the preferred stock.

 

Californian BAC shareholders will pay about 33% top rate on dividends.  That leaves only 67 cents on the dollar.

 

The preferred in aggregate yield 7% after-tax. 

 

So... in terms of after-tax dividend value, calling in preferred stock would give Californian shareholders slightly more than 10% after-tax returns.  And meanwhile, there is the add-on effect of reducing risk to the common stock.

 

I prefer buybacks too.  No argument there. 

 

I disagree about the dividend.  I don't think it did anything for Fairfax's valuation (it's not my only example).  I think stocks trade primarily on earnings and if you have them, you get the price you deserve (a lower valuation if there is uncertainty, or a full valuation if there isn't).

[xazp]

Look at JPM.  Dimon explicitly said he was preferring buybacks to dividends because dividends would raise the stock price too much.  I forget the number, but JPM did buy back + pay dividends of around $15Bn in 2011 (and pre-whale guided towards a similar amount in 2012) and they never approached a $300Bn market cap. 

 

To me $15Bn dividend = $300Bn stock.  But $15Bn in buybacks = $200Bn stock. 

 

 

 

 

I prefer buybacks which in effect are tax-free distributions to shareholders.  If BAC thinks (for example) that normalized earnings are $2/share, they should be buying back aggressively through $20.  Whatever their view of normalized earnings, I think they should buy back below 10x that number, and dividend at over 10x that number.

 

As it pertains to your preference for preferred vs dividend buybacks, I think you are overlooking the capital gains that go along with dividends.  This is mostly investor psychology. 

 

But consider this example.  Say BAC concludes it can sustainably pay out $15Bn in capital each year, and institutes a $15Bn dividend.  It's hard for me to see BAC trading at less than a $300Bn market cap.  From the equity holder's point of view, they would earn $15Bn in dividends, but $150Bn in capital gains.  The bulk of your gains come from people reacting to the dividend, not the actual dividend.  And I think that number would be far greater than paying off $15Bn in preferreds.

 

 

 

BAC also needs to issue a fair amount of preferreds over the next couple years (something like $8bn assuming no major change in RWAs) to maximize their Additional Tier 1 bucket, so net from today you are probably adding more preferreds than you take out via TruP calls. Unless you want to fill that bucket with common. I'm sure RWAs will shrink but in the end state you probably need $15-16bn in preferreds... which shakes out to about $250m in preferred dividends assuming an average 6.5% coupon. So I don't know the preferred dividend component will be shrinking too much.

 

I'm in favor of not paying a dividend, instead using the "would be" dividend cash for retirement of all of the preferred stock.

 

Californian BAC shareholders will pay about 33% top rate on dividends.  That leaves only 67 cents on the dollar.

 

The preferred in aggregate yield 7% after-tax. 

 

So... in terms of after-tax dividend value, calling in preferred stock would give Californian shareholders slightly more than 10% after-tax returns.  And meanwhile, there is the add-on effect of reducing risk to the common stock.

 

I prefer buybacks too.  No argument there. 

 

I disagree about the dividend.  I don't think it did anything for Fairfax's valuation (it's not my only example).  I think stocks trade primarily on earnings and if you have them, you get the price you deserve (a lower valuation if there is uncertainty, or a full valuation if there isn't).

[ERICOPOLY]

A $300 bn market cap for BAC suggests that they already earning $2 per share and trading for 13x earnings.

 

By contrast, JPM pays a 3% dividend and trades for only 9x forward earnings. So do you reckon that JPM would soar 44% if they raised their dividend 200  bps?

[xazp]

No, I said if JPM paid out a $15Bn regular dividend, they'd soar ~50% to a $300Bn market cap. 

 

I'm not making the argument in both directions. I am not suggesting that BAC and C should both trade at 80 cents because they pay a 4 cent dividend.  Or that Berkshire has no value because it pays no dividend. 

 

I am suggesting that it is fairly rare for Dow or S&P companies to trade at a dividend yield of greater than 5%.  Thus, if a Dow/S&P company is able to pay out $15Bn/year as a dividend, yes, I think it will trade at a minimum market cap of $300Bn. 

 

This isn't something I'm advocating or want.  I prefer buybacks precisely (as Dimon says) because they don't cause jumps in the stock price.  The compounding effect is much greater if you can continually buy back huge amounts of shares below fair value.  A 50% immediate jump in value is less than the long-term (but slower) ability to purchase lots of shares at 30% below BV or whatever. 

 

 

 

 

 

A $300 bn market cap for BAC suggests that they already earning $2 per share and trading for 13x earnings.

 

By contrast, JPM pays a 3% dividend and trades for only 9x forward earnings. So do you reckon that JPM would soar 44% if they raised their dividend 200  bps?

[Uccmal]

The problem as both of you are aware with buyacks is that they do not instill capital discipline.  JPM stopped buybacks after the whale episode.  It is unclear if BAC is going to meet the 5 billion they agreed to do in common stock.  If the number was March to March then they might well do it. 

 

Put another way I will believe it when I see it. 

 

Its not the dividend in and of itself that raises the stock price.  It is regular increases in the dividend. 

 

This is why it does nothing for Fairfax.  There is substantial data to back up the link between rising stock prices and increasing dividends. 

[ERICOPOLY]

I am suggesting that it is fairly rare for Dow or S&P companies to trade at a dividend yield of greater than 5%.  Thus, if a Dow/S&P company is able to pay out $15Bn/year as a dividend, yes, I think it will trade at a minimum market cap of $300Bn. 

 

It might be rare to have one trade with dividend yield in excess of 5%, but I think you are drawing the wrong conclusion from that.

 

I believe you also need to check the dividend payout ratio.  Is anyone on the DOW paying out enough to support a dividend yield in excess of 5%? 

 

Take At&t for example which already pays a 5% dividend.  Your theory suggests that the stock would jump 20% in response to a 20% dividend hike (paid for by cancelling share repurchases), and with no change in business results to justify it.  I would bet heavily against that if this were something we could wager on.

[ERICOPOLY]

There is substantial data to back up the link between rising stock prices and increasing dividends.

 

There is also correlation between improving company prospects and rising dividends.  But hiking the dividend doesn't raise the company prospects.

[xazp]

I don't know if it'd be a 20% jump, but, yes, I think the stock would jump by switching from buybacks to dividends.  As I said in a previous note, I don't condone that behavior, because buybacks below fair value will result in a bigger (but slower) upward movement of the stock. 

 

One explanation for that behavior could be simply that in the US dividends are fairly sacrosanct.  So when a company puts in a dividend, they are implicitly saying "we will pay at least this much to shareholders from here on out."  Of course that is a soft rule, not a hard rule.  So if BAC indeed does a $15Bn dividend, that means they have confidence they can earn enough from then onward to keep paying at least $15Bn.

 

This is somewhat codified by the Fed.  If you look at Citigroup's comments, the Fed prefers the banks to do buybacks, because they don't constitute an implicit promise to shareholders of continuing returns.

 

So I should really say, if the Fed actually allowed BAC to return $15Bn in dividends, that would mean both BAC and the Fed believed they could return $15Bn/year forever.  Whereas a $15Bn buyback simply means in the short-term BAC and the Fed believes they can return $15Bn. 

 

I am suggesting that it is fairly rare for Dow or S&P companies to trade at a dividend yield of greater than 5%.  Thus, if a Dow/S&P company is able to pay out $15Bn/year as a dividend, yes, I think it will trade at a minimum market cap of $300Bn. 

 

It might be rare to have one trade with dividend yield in excess of 5%, but I think you are drawing the wrong conclusion from that.

 

I believe you also need to check the dividend payout ratio.  Is anyone on the DOW paying out enough to support a dividend yield in excess of 5%? 

 

Take At&t for example which already pays a 5% dividend.  Your theory suggests that the stock would jump 20% in response to a 20% dividend hike (paid for by cancelling share repurchases), and with no change in business results to justify it.  I would bet heavily against that if this were something we could wager on.

[ERICOPOLY]

So I should really say, if the Fed actually allowed BAC to return $15Bn in dividends, that would mean both BAC and the Fed believed they could return $15Bn/year forever.  Whereas a $15Bn buyback simply means in the short-term BAC and the Fed believes they can return $15Bn. 

 

I agree that if they return $15b with Fed approval (as dividend no less) it will be a clear indication that both the Fed and BAC believe that things are so good that it can go on in relative perpetuity.

 

I also, however, believe that by the time the bank is in that kind of shape where they could get such approval the stock will already be up there. 

 

You know, it's funny because I've heard people say completely the opposite -- that buyback programs are just there to drive up stock prices so executives can cash out.  So here you are arguing totally the opposite. 

 

I don't claim to be right, it's just I don't follow the reasoning.  Many times I am wrong so don't take this as if I pretend to know everything simply because I argue.

[xazp]

Well analyst estimates for next year (i.e. starting in two months) are for $1.34 in earnings which is already about $15Bn.  If you add in the tax benefits, that's ~$22Bn of capital generation per year.  They are already well over both Basel 1 and Basel 3 requirements for capital. 

 

My view is that $1.34 in earnings is not only sustainable, but that BAC can increase earnings from there.  So I view $15Bn/year as sustainable.  In fact their capital ratios will continue to grow even with a $15Bn distribution, because that'd be an excess of at least $7Bn/year, and there is a substantial amount of de-risking still possible due to their old, legacy ports. 

 

So, in my mind "they are capable" of returning $15Bn/year "forever" - already.  But the stock is not a $300Bn stock. 

 

 

 

So I should really say, if the Fed actually allowed BAC to return $15Bn in dividends, that would mean both BAC and the Fed believed they could return $15Bn/year forever.  Whereas a $15Bn buyback simply means in the short-term BAC and the Fed believes they can return $15Bn. 

 

I agree that if they return $15b with Fed approval (as dividend no less) it will be a clear indication that both the Fed and BAC believe that things are so good that it can go on in relative perpetuity.

 

I also, however, believe that by the time the bank is in that kind of shape where they could get such approval the stock will already be up there. 

 

You know, it's funny because I've heard people say completely the opposite -- that buyback programs are just there to drive up stock prices so executives can cash out.  So here you are arguing totally the opposite. 

 

I don't claim to be right, it's just I don't follow the reasoning.  Many times I am wrong so don't take this as if I pretend to know everything simply because I argue.

[ERICOPOLY]

Well analyst estimates for next year (i.e. starting in two months) are for $1.34 in earnings which is already about $15Bn.  If you add in the tax benefits, that's ~$22Bn of capital generation per year.  They are already well over both Basel 1 and Basel 3 requirements for capital. 

 

My view is that $1.34 in earnings is not only sustainable, but that BAC can increase earnings from there.  So I view $15Bn/year as sustainable.  In fact their capital ratios will continue to grow even with a $15Bn distribution, because that'd be an excess of at least $7Bn/year, and there is a substantial amount of de-risking still possible due to their old, legacy ports. 

 

So, in my mind "they are capable" of returning $15Bn/year "forever" - already.  But the stock is not a $300Bn stock. 

 

 

 

So I should really say, if the Fed actually allowed BAC to return $15Bn in dividends, that would mean both BAC and the Fed believed they could return $15Bn/year forever.  Whereas a $15Bn buyback simply means in the short-term BAC and the Fed believes they can return $15Bn. 

 

I agree that if they return $15b with Fed approval (as dividend no less) it will be a clear indication that both the Fed and BAC believe that things are so good that it can go on in relative perpetuity.

 

I also, however, believe that by the time the bank is in that kind of shape where they could get such approval the stock will already be up there. 

 

You know, it's funny because I've heard people say completely the opposite -- that buyback programs are just there to drive up stock prices so executives can cash out.  So here you are arguing totally the opposite. 

 

I don't claim to be right, it's just I don't follow the reasoning.  Many times I am wrong so don't take this as if I pretend to know everything simply because I argue.

 

Alright, so they approve a $15b dividend which cannot be easily retracted.  This can go on as long as the economy goes well -- I agree.

 

Then, beginning in June, we tip back into recession and NIM gets squeezed as long rates fall again.  Perhaps the 10 yr drops to 1%.  Also, they have to boost reserves.

 

So that's why I don't think they'll approve $15b in dividends.  It cuts it too fine when you throw in recessions.  I think the Fed will let them pay out a dividend that takes recessions into consideration.  Then they will approve extra capital return above that through share repurchases -- with the intention of cutting them if recession pops up.

 

I doubt they will take into account the tax benefits when they approve the dividend -- the tax benefits will be all used up, and then what?  So they will base recurring payouts like dividends on the after-tax income IMO.