BAC-WT - Bank of America Warrants

[TheAiGuy]

If I'm honest, I basically expect nothing fancy of BofA anymore. My thesis from when I made this investment back in 2012 was that 1) BofA would survive & 2) that LAS & Litigation cost would wind down and reveal a very profitable bank. Both of those are pretty clear at this point and seem priced into the stock.

 

What I don't see is any reasons to expect further ROA expansion from the bank absent favorable interest rate developments. It looks like there is $200M a quarter left spent on LAS and that's, what, 4-5% earnings expansion? So, based on the last 2 quarters of earnings, that suggests they will earn in the $1.50-$2 range normalized. I mean, I'm happy to hold on and see if rates go up but I'm not going to make any money betting on interest rates long term. Am I missing a lever BofA has to pull to propel earnings growth?

[racemize]

If I'm honest, I basically expect nothing fancy of BofA anymore. My thesis from when I made this investment back in 2012 was that 1) BofA would survive & 2) that LAS & Litigation cost would wind down and reveal a very profitable bank. Both of those are pretty clear at this point and seem priced into the stock.

 

What I don't see is any reasons to expect further ROA expansion from the bank absent favorable interest rate developments. It looks like there is $200M a quarter left spent on LAS and that's, what, 4-5% earnings expansion? So, based on the last 2 quarters of earnings, that suggests they will earn in the $1.50-$2 range normalized. I mean, I'm happy to hold on and see if rates go up but I'm not going to make any money betting on interest rates long term. Am I missing a lever BofA has to pull to propel earnings growth?

 

I guess there's also the fact that it is trading at tangible book value and that value increased 10% in the last year.  Given the lack of taxes, there should be continued decent growth in that value.  Thus, if you based valuation on TBVPS, you might expect 10%ish growth for a while.

[jay21]

If I'm honest, I basically expect nothing fancy of BofA anymore. My thesis from when I made this investment back in 2012 was that 1) BofA would survive & 2) that LAS & Litigation cost would wind down and reveal a very profitable bank. Both of those are pretty clear at this point and seem priced into the stock.

 

What I don't see is any reasons to expect further ROA expansion from the bank absent favorable interest rate developments. It looks like there is $200M a quarter left spent on LAS and that's, what, 4-5% earnings expansion? So, based on the last 2 quarters of earnings, that suggests they will earn in the $1.50-$2 range normalized. I mean, I'm happy to hold on and see if rates go up but I'm not going to make any money betting on interest rates long term. Am I missing a lever BofA has to pull to propel earnings growth?

 

They have X in capital that earns negative returns. If they can repurpose that capital to earn additional money.

 

Its unclear how settlement overhangs have affected their capital retention. As these get removed, they may be able to hold less capital and return more of earnings.

 

Efficiency ratio upside.

 

I mean, will it be the eye popping returns from buying ~$5? Probably not, but the risk/reward seems compelling.

 

 

I guess there's also the fact that it is trading at tangible book value and that value increased 10% in the last year.  Given the lack of taxes, there should be continued decent growth in that value.  Thus, if you based valuation on TBVPS, you might expect 10%ish growth for a while.

 

Good point. They will grow capital faster b/c they will be doing it on a pre-tax basis.

[TheAiGuy]

If I'm honest, I basically expect nothing fancy of BofA anymore. My thesis from when I made this investment back in 2012 was that 1) BofA would survive & 2) that LAS & Litigation cost would wind down and reveal a very profitable bank. Both of those are pretty clear at this point and seem priced into the stock.

 

What I don't see is any reasons to expect further ROA expansion from the bank absent favorable interest rate developments. It looks like there is $200M a quarter left spent on LAS and that's, what, 4-5% earnings expansion? So, based on the last 2 quarters of earnings, that suggests they will earn in the $1.50-$2 range normalized. I mean, I'm happy to hold on and see if rates go up but I'm not going to make any money betting on interest rates long term. Am I missing a lever BofA has to pull to propel earnings growth?

 

They have X in capital that earns negative returns. If they can repurpose that capital to earn additional money.

 

Its unclear how settlement overhangs have affected their capital retention. As these get removed, they may be able to hold less capital and return more of earnings.

 

Efficiency ratio upside.

 

I mean, will it be the eye popping returns from buying ~$5? Probably not, but the risk/reward seems compelling.

 

 

I guess there's also the fact that it is trading at tangible book value and that value increased 10% in the last year.  Given the lack of taxes, there should be continued decent growth in that value.  Thus, if you based valuation on TBVPS, you might expect 10%ish growth for a while.

 

Good point. They will grow capital faster b/c they will be doing it on a pre-tax basis.

 

Those are both good points, thanks.

 

Edit:

It looks like they have about $52B in assets devoted to LAS. With a $200M/Quarter rate of losses and assuming they can reallocate that capital to get a 1% return, then that is a swing of $325M/Quarter. That's about 7%. I can't address either of your other points but they seem reasonable and certainly not priced into the stock.

[ERICOPOLY]

The claim is that ZIRP is inflating asset prices.  So beware if interest rates go up and asset prices go down.

 

BAC is exactly the opposite.  ZIRP is responsible for asset deflation of BAC because ZIRP is deflating it's earnings and the thing is trading at 1.02x tangible book versus 1.3x or 1.4x if the interest rate environment were normal.

 

Other than that, I just don't quite understand why there is not more enthusiasm amongst speculators for a stock with such a dependable and low P/E when there is so much cheap money available -- it's one of the only things you can leverage at low interest rates that would actually benefit in a major way if the Fed were to surprise you with a rate hike.  Normally that would be the primary fear of using leverage during low interest rates -- that if rates went up, you'd get pummeled.  But not with BAC.  I mean you would WANT that to happen, but you don't need it to happen. 

[frommi]

 

Other than that, I just don't quite understand why there is not more enthusiasm amongst speculators for a stock with such a dependable and low P/E when there is so much cheap money available -- it's one of the only things you can leverage at low interest rates that would actually benefit in a major way if the Fed were to surprise you with a rate hike. 

 

It`s because we are looking at deflation at the moment, look at the transcript from Fastenal that gives a good look at the current state of americas industrial sector. Nobody is really expecting the FED to raise rates over the next 6-12 months anymore.

[ERICOPOLY]

 

Other than that, I just don't quite understand why there is not more enthusiasm amongst speculators for a stock with such a dependable and low P/E when there is so much cheap money available -- it's one of the only things you can leverage at low interest rates that would actually benefit in a major way if the Fed were to surprise you with a rate hike. 

 

It`s because we are looking at deflation at the moment, look at the transcript from Fastenal that gives a good look at the current state of americas industrial sector. Nobody is really expecting the FED to raise rates over the next 6-12 months anymore.

 

6-12 months doesn't have much to do with the valuation.  What would that do if they hiked it today, maybe raise earnings by 30 cents over the next year?  Okay, so that bumps BAC's market valuation up from $15.70 to $16.00.  That's immaterial.

 

Who is "we" that is expecting deflation?  The market?  Does the valuation of the Russell2000 and S&P500 reflect a deflation thesis?

 

 

 

 

[jay21]

I think O&G drags are already priced in. They didn't say anything new.

[frommi]

6-12 months doesn't have much to do with the valuation.  What would that do if they hiked it today, maybe raise earnings by 30 cents over the next year?  Okay, so that bumps BAC's market valuation up from $15.70 to $16.00.  That's immaterial.

 

Who is "we" that is expecting deflation?  The market?  Does the valuation of the Russell2000 and S&P500 reflect a deflation thesis?

 

The bond market, stock investors still think it temporary. My guess is that the next FED action is QE4, but thats a long way out. Bank earnings are cyclical and we are closer to the top of the cycle than to the bottom. But hey, thats only my opinion.

[merkhet]

 

Other than that, I just don't quite understand why there is not more enthusiasm amongst speculators for a stock with such a dependable and low P/E when there is so much cheap money available -- it's one of the only things you can leverage at low interest rates that would actually benefit in a major way if the Fed were to surprise you with a rate hike. 

 

It`s because we are looking at deflation at the moment, look at the transcript from Fastenal that gives a good look at the current state of americas industrial sector. Nobody is really expecting the FED to raise rates over the next 6-12 months anymore.

 

All the companies that Fastenal points to for industrial recession seem to be companies that are affected by the oil & gas downturn. I don't think it's representative of industrial demand as a whole.

[frommi]

All the companies that Fastenal points to for industrial recession seem to be companies that are affected by the oil & gas downturn. I don't think it's representative of industrial demand as a whole.

 

I mean, if you look at where we’ve done a great job in the last three or four years, it’s heavy industry, and that heavy industry has dropped tremendously. Dan mentioned oil and the strong dollar. The other big one is agriculture for us, and mining and, things like that, so the gap between us signing a lot of--you know, more accounts and our national account performance, it’s two different things right now.

 

Maybe i misinterpreted this, but for me this sounds like it was more than only O&G.

[gary17]

great quarter IMO !

[Uccmal]

The claim is that ZIRP is inflating asset prices.  So beware if interest rates go up and asset prices go down.

 

BAC is exactly the opposite.  ZIRP is responsible for asset deflation of BAC because ZIRP is deflating it's earnings and the thing is trading at 1.02x tangible book versus 1.3x or 1.4x if the interest rate environment were normal.

 

Other than that, I just don't quite understand why there is not more enthusiasm amongst speculators for a stock with such a dependable and low P/E when there is so much cheap money available -- it's one of the only things you can leverage at low interest rates that would actually benefit in a major way if the Fed were to surprise you with a rate hike.  Normally that would be the primary fear of using leverage during low interest rates -- that if rates went up, you'd get pummeled.  But not with BAC.  I mean you would WANT that to happen, but you don't need it to happen.

 

Well, there are dozens of mega cap companies that pay out much higher dividends than BAC.  It could be that simple.  Getting the div. up to 0.50 cents per year probably brings BAC in line with its peers.  I expect many funds are locked out by their charters at the moment.

[ERICOPOLY]

A Bloomberg video interview of Moynihan today has him saying that their target is 12% ROTCE.  So that's $1.86 per share and that it would take a couple of years to get there.

 

It's nice that they are being a bit more realistic -- remember when Bruce Thompson in early 2014 told Mike Mayo that it would be difficult to believe that they'd be making less than $2 per share in 2016?  I imagine that's why they had to let him go, putting out such expectations they cannot hit, if not one of the reasons. 

 

[benchmark]

A Bloomberg video interview of Moynihan today has him saying that their target is 12% ROTCE.  So that's $1.86 per share and that it would take a couple of years to get there.

 

It's nice that they are being a bit more realistic -- remember when Bruce Thompson in early 2014 told Mike Mayo that it would be difficult to believe that they'd be making less than $2 per share in 2016?  I imagine that's why they had to let him go, putting out such expectations they cannot hit, if not one of the reasons.

 

Maybe Bruce was assuming that interests rate would have been raised lot sooner?

 

If it really takes two years from now to get to $1.86 earning, then the stock isn't cheap at the current level.

[ERICOPOLY]

A Bloomberg video interview of Moynihan today has him saying that their target is 12% ROTCE.  So that's $1.86 per share and that it would take a couple of years to get there.

 

It's nice that they are being a bit more realistic -- remember when Bruce Thompson in early 2014 told Mike Mayo that it would be difficult to believe that they'd be making less than $2 per share in 2016?  I imagine that's why they had to let him go, putting out such expectations they cannot hit, if not one of the reasons.

 

 

 

Maybe Bruce was assuming that interests rate would have been raised lot sooner?

 

If it really takes two years from now to get to $1.86 earning, then the stock isn't cheap at the current level.

 

It's fairly cheap as far as low risk things go -- basically the stock is acting like they will only be generating roughly 36 cents per year before now and then.  Not per quarter, per year.

 

Personally I think 36 per year is a low expectation.

 

 

I'll explain what I mean:

10x multiple on $1.86 would be an $18.60 stock price.

 

Today the stock is a full $3 less than that.

 

Going by Q3 earnings, they are currently earning $1.50 a share.

 

Anyways, $3 discount applied over two years is $1.50 per year.

 

$1.86 - $1.50 = $0.36

 

So by discounting the stock price by $3, or $1.50 a year for the next two years, the market is basically pricing in only $0.36 in earnings over the next two years.  Even though they currently made more than that in each of the past two quarters.

 

Or the market doesn't believe they can earn 12% ROTCE in two years. 

 

 

[ERICOPOLY]

Another way of saying it is this:

 

Stock price at 10x $1.86 is $18.60.

 

Earnings at $1.50 per year for first two years comes in 72 cents light cumulatively.

 

So 10x earnings would be a stock price of $17.88 after subtracting off 72 cents (which is actually a bit too much subtracted because of the time value of money).

 

$17.88 would be on the light side considering that there would be gradual and incremental progress between now and then.  So it wouldn't be a shortfall of 36 cents a year if the earnings steadily improved.

 

Anyways...

 

Stock today is roughly $2.24 below that 10x multiple.

 

So it trades at less than 9x multiple because today's price is more than a full year's worth of $1.86 earnings below the adjusted level of $17.88 (which is 10x earnings less the 72 cents of earnings shortfall).

 

[jay21]

You are actually leaving in room for upside. That retained capital compounds over time. So your base for applying 12% ROTCE is off.

 

Also, if they can get there in 2017 then the value on 12/31/16 should be $18.6 because you take fwd earnings when determining PVs (so you are saying they underearn for 2 years then hit 12% in 3 years and the capital they retain doesn't compound).

 

But yeah - Im looking at it as min 10x current earnings and has the most options relative to other banks (I think).

[ERICOPOLY]

The owner's earnings yield for BAC is greater than 11% given that  it currently trades for less than 9x earnings as reasoned in my prior post.

 

So again... with such low interest rates, why is a franchise like BAC priced to generate 11% owner's earnings yield?  Isn't there all this easy money pushing up asset prices, and so why does easy money hate 11%?  Just a bit of leverage and you are in the teens -- which with these crazy low margin rates these days is really easy.  And again, if they surprise you with a rate hike it only gives a tailwind.

 

 

[ERICOPOLY]

You are actually leaving in room for upside. That retained capital compounds over time. So your base for applying 12% ROTCE is off.

 

Also, if they can get there in 2017 then the value on 12/31/16 should be $18.6 because you take fwd earnings when determining PVs (so you are saying they underearn for 2 years then hit 12% in 3 years and the capital they retain doesn't compound).

 

But yeah - Im looking at it as min 10x current earnings and has the most options relative to other banks (I think).

 

I'm not ignoring the retained capital.  It isn't material to my study.  Mentioning it isn't necessary.

 

What I'm doing is asking what it would be worth today if it was already earning $1.86 right now.

 

So I come up with a present value for today of $18.60.

 

So the stock is worth $18.60 today provided that from this day onwards, they earn $1.86.

 

So you just knock 72 cents off of that price because for the first two years they only earn $1.50.  And that's pessimistic if the expectation is that they'll earn gradually more and more each quarter over the next two years.

 

So knocking 72 cents off of today's $18.60 valuation bring us to $17.88.

 

And today's REALITY stock price is only $15.64.

 

And that's fully $2.24 discount below our adjusted (for low first 2 year earnings) price of $17.88.

 

And $2.24 exceeds the $1.86 per year that BAC earns (excepting the first two years already discounted in the $17.88 price).

 

THEREFORE, it trades at less than 9x earnings today.  It has to be less than 9x because $2.24 exceeds a year of earnings.

[maverick]

The claim is that ZIRP is inflating asset prices.  So beware if interest rates go up and asset prices go down.

 

BAC is exactly the opposite.  ZIRP is responsible for asset deflation of BAC because ZIRP is deflating it's earnings and the thing is trading at 1.02x tangible book versus 1.3x or 1.4x if the interest rate environment were normal.

 

Other than that, I just don't quite understand why there is not more enthusiasm amongst speculators for a stock with such a dependable and low P/E when there is so much cheap money available -- it's one of the only things you can leverage at low interest rates that would actually benefit in a major way if the Fed were to surprise you with a rate hike.  Normally that would be the primary fear of using leverage during low interest rates -- that if rates went up, you'd get pummeled.  But not with BAC.  I mean you would WANT that to happen, but you don't need it to happen.

 

What if the market is pricing that we may stay stuck in a low rate environment for a long time. Market's projections of forward Fed Funds rate is lower than the Fed's own projections - this means that the market doesn't believe the Fed. The same is true for a rate increase this year. In spite of Yellen's, Dudley's, and Fischer's rhetoric of a rate increase in 2015, the market is currently only implying 30%-40% probability of a rate hike in 2015. The market doesn't seem to believe the Fed's rhetoric. The US economy is slowing down and no one can say right now with certainty if we will be able to attain a soft landing or if it would be a hard landing. If the Fed were to increase rates in a slowing economy, it may well have to reverse course in the near term.

 

Short term rates staying low is keeping long term rates anchored. Banks lending rates (such as for mortgages) are tied to the long rates. Lower long term rates mean lower lending rates. Banks NIM is under pressure due to lower lending rates. If the yield curve were to flatten (if the Fed were to raise short term rates) that could put further pressure on the NIM.

 

Banks used to make a lot of money in fixed income trading. There too revenues are down as trading volume is down.

 

New regulations mean that the banks can't lever up as much as they used to do in the past. So in the near to intermediate term it could be difficult to be extremely profitable.

 

Just a few of my thoughts. I do own BAC though.

[gary17]

anyone know how much dividend the Fed  will approve based on current eps?

[meiroy]

Does http://www.federalreserve.gov/ show anywhere how they adjust [LTM?] earnings for CCAR?

[redskin]

anyone know how much dividend the Fed  will approve based on current eps?

 

They need a minimum of 6% tier 1 common ratio in a severely adverse scenario.  BAC had excess capital of over $20 billion last year, so I don't think this will be a problem.

 

It is my understanding they can return all earnings from the previous 12 months as long as they meet the minimum capital requirement in severely adverse scenario.  Since BAC has earned over $16 billion over last 12 months I think they'll be able to return all of that to shareholders in dividends and buybacks.  I'm hoping for unchanged dividend and the rest in buybacks.

[ERICOPOLY]

anyone know how much dividend the Fed  will approve based on current eps?

 

They need a minimum of 6% tier 1 common ratio in a severely adverse scenario.  BAC had excess capital of over $20 billion last year, so I don't think this will be a problem.

 

It is my understanding they can return all earnings from the previous 12 months as long as they meet the minimum capital requirement in severely adverse scenario.  Since BAC has earned over $16 billion over last 12 months I think they'll be able to return all of that to shareholders in dividends and buybacks.  I'm hoping for unchanged dividend and the rest in buybacks.

 

And $16 billion is just the net income.  They generated a lot more capital than that due to the tax thingy.  So even if they returned all $16 billion, they would still have built capital and left with even more excess than last year under the same scenario.  Plus it just keeps coming in the door at $20b a year pace.  So even while they are returning the $16 billion they would still be continuing to build capital.

 

And at $16.03 today, it's at 9x earnings.  Because it's so risky ya know.