BAC-WT - Bank of America Warrants

[onyx1]

The following would result in much higher stock price for BAC in 2018:

4.) Mr Market falls in love with bank stocks and bids up PE ratio

 

Red meat for the bulls:

 

This morning on CNBC, Jim Cramer said his contacts in the big banks say they haven't even begun see lending accelerate from easing regulation. 

 

Cramer then opined the a 10x - 14x multiple for big banks is crazy, they are now growth companies.

[StubbleJumper]

The following would result in much higher stock price for BAC in 2018:

4.) Mr Market falls in love with bank stocks and bids up PE ratio

 

Red meat for the bulls:

 

This morning on CNBC, Jim Cramer said his contacts in the big banks say they haven't even begun see lending accelerate from easing regulation. 

 

Cramer then opined the a 10x - 14x multiple for big banks is crazy, they are now growth companies.

 

 

Cripes, if Cramer is recommending BAC, maybe it's time to sell!

[HalfMeasure]

The following would result in much higher stock price for BAC in 2018:

4.) Mr Market falls in love with bank stocks and bids up PE ratio

 

Red meat for the bulls:

 

This morning on CNBC, Jim Cramer said his contacts in the big banks say they haven't even begun see lending accelerate from easing regulation. 

 

Cramer then opined the a 10x - 14x multiple for big banks is crazy, they are now growth companies.

 

As much as it pains me, I actually kind of agree with this. I know that historically financials sell at a discount to the market, but this feels very different. Post-crisis, financials have pared back leverage significantly which used to be one of the reasons for the discounted multiple (risk profile). The industry consolidated in a major way coming out of the crisis. We're in a rising interest rate environment from extreme historical lows. Regulation is likely at a peak. And financials aren't selling at a couple turn discount, the market is ~20x forward earnings and high quality financials are well below.

[rogermunibond]

OTOH given asset prices in most countries what on earth could banks lend to or for what purposes that wouldn't likely be huge misallocations of capital.

 

Save deferred infrastructure capex and growth infrastructure capex generally.

 

Hmmm.  Doesn't Trump have an infrastructure program being queued up for the SOTU?

[John Hjorth]

Here is the link to Cramer: CNBC MadMoney: Cramer remains confident on most major banks after earnings.

 

Personally, I don't think he's talking rubbish - here. Please note how he ranks the 4 big US banks. Personally I perceive them among each other exactly that way. Please note, perhaps I've here delivered written proof of, that I'm dumb, too. [ ; - ) ]

[Viking]

As I read more reports post Q4 earnings release, it looks to like estimates for earnings for BAC will come in as follows:

2018 = $2.60/share = 12.15PE (with shares trading today at $31.60)

2019 = $3.10/share = 10.20PE

 

The big US banks are currently trading close to 10 times 2019 earnings estimates. That is not expensive. That is not euphoric. The big US banks likely remain the most hated asset class in the market; show me another asset class that is trading at 10X 2019 earnings? And the best part? They are growing their business, total profits and paying +100% of earnings to investors. My read is bank stocks are still not loved. More importantly, they remain terribly misunderstood. They are safer than they have been in decades. They are overcapitalized. All the consolidation that happened in the Great Financial Crisis has created an oligopoly of sorts (less competition). Their European competitors are weak.

 

2018 is going to be a watershed year for the big US banks. The shackles from the Great Financial Crisis are finally going to be thrown off and we are going to see just how profitable they really are. When people look at the big banks today they still see the ugly caterpillar (message boards are still littered with comments from investors who were burned by the banks burning the Great Financial Crisis); over the course of 2018 as the big banks report their results and hold their investor days investors are going to understand the transformation that has been happening over the past decade and will finally see the big US banks as beautiful butterflies.

 

From my perspective, there are many different things that can happen in 2018 that will boost bank earnings even higher:

1.) If we are indeed getting a synchronized global expansion and GDP growth may surprise to the upside; higher GDP growth is the best single thing that can happen to banks in 2018 (more loans and more spending).

2.) This may lead to more rate increases than expected from the Fed and we may actually see the yield on the US 10 year move higher; I think BAC has said a 100 basis point increase in interest rates will provide a $3.3 billion benefit with 67% of the benefit coming from the short end of the yield curve.

3.) ECB in 2H 2018 may finally start on its tightening campaign; this should lead to increase in 10 year bond yields in global markets.

4.) We may see a infrastructure spending bill from congress; in the short run this will stimulate growth.

5.) Inflation, lead by wage growth, may finally pick up.

6.) Bank deregulation is coming in 2018; we won’t know exact details until it happens but end result will make the banks more profitable. The heads of the various departments did not get confirmed until late in 2017 so analysts are saying there is a high probability regulatory relief is actually coming in 2018.

7.) Banks will be approved for record amounts during the upcoming CCAR cycle - likely to return more than 100% of earnings which are jumping in 2018 due to tax reform and growing economy; BAC may be approved to return $25-$30 billion (when awards are made in June)

8.) Banks remain overcapitalized ($10-15 billion depending on bank) and regulators will allow this also to be returned to shareholders; this would make CCAR payouts even higher.

9.) dividend payouts will be jumping massively for all banks (+50%) driven by tax reform and higher total earnings; BAC will move from $0.12/quarter to closer to $0.20/quarter. Big bank shares will become more popular with dividend funds.

10.) volatility may return in 2018 and capital markets activity may finally pick up, lead by IPO’s, mergers and acquisition activity. Investment banking businesses at banks may improve.

11.) bad loan portfolios in runoff (bad loans from 2008 financial crisis) continues to shrink in size at BAC and C and will be less of a drag on total company loan growth.

 

Based on my 11 points above, my guess is 2019 earnings estimates will be going up during 2018. The challenge for investors is we do not know which of the 11 points above will happen and when. I am just very confident that a couple will happen and when they do it will make the banks even more profitable. But it will play out slowly. The big money is made by sitting on your hands and doing nothing. Time, after all, is the friend of the patient investor. :-)

 

PS: what is the key risk? A recession; as long as the US and world economy continues to grow I am very happy to hold my bank stocks.

 

[John Hjorth]

Absolutely awesome post, Viking! - Thank you!

 

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The last two days I have been in some kind shock, in combination with a feeling af bliss, bordering to get rollicking. I try to keep my mouth shut here on CoBF, to not appear stupid. [To no avail, just see my last post in this topic.]

 

I'm just sitting, after reading I don't how many pages of reports from the Big Four US banks, and I'm thinking: "What? - Is this - the actual price of these banks on NYSE - really true?"

 

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Partly on topic, but at least BAC related:

 

First, & right now, I just need to cool down.

 

Second, when I've become rational and non-emotional again, here is what has been going on in my mind the last couple of days:

 

I hold all the cash in taxable accounts & I'm fully invested in tax deferred accounts. [Cash isen't cash to me, if it's not available without a tax haircut], thus:

 

1. Move all Berkshire shares from tax deferred accounts by calling the broker, thereby to generate cash in tax deferred accounts - just need to do the calculus if it's doable in full, or only partly - I think it is doable in full.

2. Do a swing - in tax deferred accounts - a fairly big one - against these US banks, using a basket approach, I just have to think about if WFC should be in the basket also. Simply going from having quite some liquidity to get fully invested. For me, very heavy on these banks, thereby by a large margin surpassing my large [ & largest] Berkshire position [,that is not for sale on this].

 

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What is S&P500 forward P/E right now? - Somewhere in the area of 25, I think. These banks are trading right now at short term forward P/Es in the low teens.

 

Are these Big Four US bank stocks quality? To me, yes, but of a varying quality. Are these stocks growth stocks? To me, no, not really. But there is in general growth in them above US GDP growth. That's a material point to me. Furthermore, this is not right question to ask. The right question to ask to me actually is: Are these stocks growth stocks, based on per share basis. That's totally different question, and to me also with a totally different answer, because the answer is a resounding yes, because of the enourmous share buyback programs in progress in these banks. So to me these banks aren't exactly growth stock as such, but it seems more reasonable to label them as compounders and/or - more or less - cannibals. Priced in the market - relatively - like they are - perhaps not as crappy, but at least as semi-crappy - at least as hated, as also mentioned by Viking.

 

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So, to me, this is it - it's time to swing.

[Viking]

John, for long term investors, I think the big US banks are a pretty good place to be. They all have very different business models so holding a basket makes a lot of sense, especially if the intention is to hold them long term. Some will do better when capital markets activity picks up. Others will do better with global growth. Others do better when US growth picks up. Some are more US$ sensitive. They are also at different stages of their metamorphosis. And they all trade at different valuations.

 

My understanding is Berkshire is one of the largest winners with tax reform. I actually have it on my watch list. I was going to pull the trigger in late December but was too busy sucking my thumb. And it has been on fire in January so I am going to pass for now.

 

The markets have been on an absolute tear since Trump was elected. And the economic news is very good and is getting better (in aggregate). I wonder how long the music will keep playing before we get at least a small correction. It’s almost as if all the people at the ball know it is going to end soon so they have grabbed their partner to get in as many dances as they can before the music stops. :-)

 

The yield on the 10 year US treasury closed today at 2.62%; Gundlach said 2.63% is the key level (and we are knocking on the door) and if that level is breached we should see yields move higher (closer to 3% over the year). At some point higher bond yields will become an issue.

[Viking]

The following would result in much higher stock price for BAC in 2018:

4.) Mr Market falls in love with bank stocks and bids up PE ratio

 

Red meat for the bulls:

 

This morning on CNBC, Jim Cramer said his contacts in the big banks say they haven't even begun see lending accelerate from easing regulation. 

 

Cramer then opined the a 10x - 14x multiple for big banks is crazy, they are now growth companies.

 

As much as it pains me, I actually kind of agree with this. I know that historically financials sell at a discount to the market, but this feels very different. Post-crisis, financials have pared back leverage significantly which used to be one of the reasons for the discounted multiple (risk profile). The industry consolidated in a major way coming out of the crisis. We're in a rising interest rate environment from extreme historical lows. Regulation is likely at a peak. And financials aren't selling at a couple turn discount, the market is ~20x forward earnings and high quality financials are well below.

 

The challenge for investors when trying to value the big banks is their is so much noise in their reported results in Q4 it is very confusing. Right now for BAC Yahoo Finance shows net earnings of $1.56/share and a PE of 20. Sure doesn’t look cheap!

 

When i factor out the one time items due to tax reform and adjust the tax rate (to 19%) it look to me like BAC would have earned about $2.20/share in 2017 = 14.3PE on a trailing basis. This does not look expensive to me given it’s strong growth prospects. As BAC reports results in 2018 investors will come to better understand the story. As the companies do their investor days and continue to communicate how the plan is coming together this will also help investors.

 

To get to earnings of $2.60 in 2018 then BAC will need to increase earnings about $0.40/share = 18%. I expect lower share count (stock repurchases) to account for 5-6%. A chunk of increased earnings will come from higher interest rates. They will also be growing their business while holding the line on expenses (at about $53.5 billion). $2.60/share looks pretty doable to me.

[John Hjorth]

As much as it pains me, I actually kind of agree with this. I know that historically financials sell at a discount to the market, but this feels very different. Post-crisis, financials have pared back leverage significantly which used to be one of the reasons for the discounted multiple (risk profile). The industry consolidated in a major way coming out of the crisis. We're in a rising interest rate environment from extreme historical lows. Regulation is likely at a peak. And financials aren't selling at a couple turn discount, the market is ~20x forward earnings and high quality financials are well below.

 

Well said, HalfMeasure,

 

The point is also, that these banks have been subject to massive regulation, control and added regulatory reporting to an extent that was abosolutely unheard of pre GFC. Viking has earlier expressed it in the way that they have become utility-like in that respect. All with the purpose that there will be no GFC repetition, at least not with the banks triggering such a scenario, as last time.

 

The banks got public help with capital to preserve trust in them at the worst times back then, but other than that, they have basically had to work their way out of all the issues themselves [loan losses, litigation etc.]. Pure Baron Munchhausen. It has only been possible because of the built in and very strong underlying earnings power in these money machines, combined with that they have been given the needed time to get out of the mud.

 

In short, there is an element of hindsight bias involved here. At least, personally I struggle with that here. We need to look at BAC forward, not too much in the rear mirror. The past of the bank is the basis for understanding where the bank is today, though, so naturally it matters.

[John Hjorth]

Viking,

 

Every time you post in the topics about the Big Four US Banks in the CoBF Investment Ideas forum, to me it's like some some decree [please don't take it too seriously - it's actually self induced] - decree - of forced working late hours! - I really hope that you can read this as some kind of compliment - because it's actually meant that way. [ ; - ) ]

 

I try to do my best to follow your line of thoughts by reading and learning - building "the Map", inside my brain. Not always easy, because some of it is actually macro stuff, or at least macro related.

 

I'm so exhausted at times, but it feels good! - Brain Massage!

 

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The EUR / USD is really teasing me nowadays. I have opened a separate topic about it here, not to clog up this topic.

 

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Last night I read The Latest Client Memo from Mr. Marks: Latest thinking.

 

Somehow, it's striking to me, to which degree this is in line with your thoughts here.

 

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Off topic:

 

That Mr. Marks Client Memo also bent to me in neon, why Onyx1 is on a real estate hunt in the Southern US. I was actually more than surprised by reading that part of the Memo.

 

- - - o 0 o - - -

 

Thank you for sharing your thoughts here on CoBF.

[Viking]

Bank of America CEO Moynihan Says the 'U.S. Economy Is Growing Well' https://finance.yahoo.com/video/bank-america-ceo-moynihan-says-161107508.html

 

My key takeaway from listening to this 13 minute video was around capital return. Moynihan said BAC currently has $20 billion in excess capital and they want to return this to shareholders. They will earn about $27 billion in 2018. It will be very interesting to see how much capital they are approved to return to shareholders when CCAR results are announced in June. I think $25 billion is low; this number means they will still be building capital. I think a total of $30 billion might be possible (share repurchases and dividends).

 

Here is where it really gets interesting. Moynihan suggests the capital ratios the banks are required to hold may be coming down as part of regulatory reform in 2018 (I think they are currently required to hold 10.5% plus a 1% buffer). If this is reduced in 2018 by 1% then Moynihan said BAC will have an additional $16 billion in excess capital.

 

To summarize:

1.) excess capital today = $20 billion

2.) 2018 est net earnings = $27 billion

3.) Lower Capital Levels = $16 billion (if 1% reduction) $8 billion (if 0.5% reduction)

 

By the end of this year BAC could have $63 billion in excess capital (less dividends paid and shares repurchased during the year). Not to say this will happen. Rather, just trying to identify the tailwinds that might happen in 2018 and if they do what the financial impact might be.

 

As a point of reference, BAC’s current market cap is $331 billion.

 

Last year the first catalyst to hit the bank stocks was CCAR announcements in June when the big US banks were approved to return much higher amounts than expected (more than 100% of earnings in some cases). The second catalyst was the Fed raising rates 3 times in 2017 and an expectation that they would raise 3 times in 2018. The third catalyst was tax reform. Each of these were not knowable at the start of 2017 (exact details and timing); however, each of these activities were known to investors at the start of 2017 as possible events.

 

So here we are at the start of 2018. The big US banks have lots of catalysts that, if they happen, will drive earnings higher than currently expected in 2018. The uncertainty is not IF one or more of the catalysts will happen but rather WHEN. Time is the friend of the wonderful business.

[racemize]

I've been working on figuring out dilution of the big banks, and found it to be a little harder than I thought.  I've used the following approach to get a rough idea for BAC:

 

buyback for 2016: 0.33275

Change in shares for 2016 and 2015: 0.300631

Difference (= dilution): 0.032119

Dilution %: 0.32%

 

Anyone done this exercise or point out any issues?

[Rasputin]

I use statement of changes in shareholders equity for this.

 

For example in 2016, common stock issued under employee plans and related tax effects was 5.111 million shares, common stock repurchased was 332.750 million shares. 

 

Out of JPM BAC and WFC, you will find BAC treat their shares with most reverence.

[Rasputin]

From 2017 10Ks for WFC, BAC, JPM:

 

BAC

 

Number of shares repurchased in 2017 : 508.653 million

Number of shares issued in 2017 (employee benefits and comp) : 43.329 million

 

JPM

 

# of shares repurchased : 166.56 million

# of shares issued : 24.5 million

 

WFC

 

# of shares repurchased : 196.52 million

# of shares issued (adjusted for warrants exercise) : 47.39 million

[Rasputin]

new capital rule

 

https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20180410a1.pdf

 

bad news for C

[Viking]

BAC released Q1 results today and they were very good. All of their business units look to be performing well. Moynihan is not as polished as Dimon but Moynihan is over delivering on promises. Most importantly, they seem to be building some momentum and delivering $2.60/share in earnings in 2018 is looking on track.

- they are growing the top line revenue while keeping costs flat and this is resulting in positive operating leverage.

- they appear to be doing well with the shift to digital banking; this is allowing them to remove costs which are then reinvested in the business. They said call center volume was down 12% as more business is transacted though digital channels. Total branch count fell 3%. Total employees fell 1% (masking that they are adding people to certain parts of business to drive revenue).

- BAC is forecasting US GDP growth of 2.9% for 2018. They must be thinking growth will pick up in 2H 2018.

- NII benefit = $3 billion with 100 basis point parallel shift in interest rates; 75% of benefit is on short end. I think this means NII grows about $280 million per quarter for each 25 basis point increase in fed funds rate.

- capital return (dividend and buyback) is kicking in = $6 billion in Q1. Share count was reduced by 1.5% in quarter. Moving forward I think they will be able to retire 4.5 to 5% of shares (including stock awards) while paying 2 to 2.25% dividend = 6.5 to 7.25%

- Berkshire warrants were exercised in Q3 of 2017 and added 700 million common shares. BAC reduced shares outastanding by around 500 million Q1 rolling 12 months. In less than 18 months BAC will offset dilution of Berkshires shares. Pretty amazing size of capital return and benefit to long term shareholders. You really see this with a Citi and how much share repurchases are bringing down share count; BAC is just getting started :-)

- Dick Bove said they turnaround the last couple of years has been remarkable. He also expressed concern that BAC is not growing total shareholder capital. CEO said they did not grow total capital this quarter due to $6 billion in capital return and $4 billion hit to AOCI. Company said they have lots of excess capital and ability to grow business in future as required by customers.

- a question was asked regarding the new rule proposals from the Fed and it sounds like BAC may benefit; sounds to me like all the banks have some concerns with the new proposals and will be making submissions during the comment period.

 

Can someone help me understand what impact the $4 billion hit to AOCI means to their business?

(Net change in debt and equity securities =$3.9 billion). I think BAC said it is not a big deal as the assets impacted will be held to maturity but I may be misunderstanding.

 

 

[LC]

Can someone help me understand what impact the $4 billion hit to AOCI means to their business? I think BAC said it is not a big deal as the assets impacted will be held to maturity but I may be misunderstanding.

 

From my accounting days and I may be mistaken, but I believe some assets when they are determined to be impaired, that charge flows through AOCI.

 

https://www.accountingtools.com/articles/the-other-than-temporary-impairment-concept.html

 

However I am not sure why BAC is saying not to be concerned about this $4b charge. If the assets are indeed impaired, what does holding them to maturity matter? Their market price has just decreased.

[Viking]

LC, my guess is it has something to do with the big move in the 10 year yield. Thanks for the quick reply :-)

[marazul]

These assets are not impaired, they are just bonds held as available for sale...bonds fell sharply during q1 because of the rise in rates...banks need to hold FI securities as they need liquid assets that yield something, they can´t lend every single penny in the balance sheet...most banks experienced the same issue...nothing material, eventually this will mature and be paid at PAR

[onyx1]

 

Analyst:

"In terms of expenses, Paul and Brian, you've -- you're on track clearly to get to your target of the ballpark

$53 billion for this year. I think you've said that you can also kind of stay in that ballpark in 2019 and

2020, even with the investments and the build-outs that you're doing. Is that still the view? And how is

that possible? Are you self-funding that with some saves elsewhere? If you could talk about that, it would

be helpful."

 

Brian Moynihan:

"Yes, John, it's our view, what we said, I think, last quarter, the investments we'll make are -- will be

funded with the hard work in operating leverage and Simplify and Improve and organizational health and

operational excellence. And we announced the investments we're making in the retail business. It's all

contemplated with -- in the low $53 billion level, which we ought to be able to maintain in '19 and '20. And

if we're going to make any further investments, it'll be modest, as we said. But right now, it looks like it's

shaking out to be okay."

 

Loved this exchange.  0% expense growth and 5% core loan growth (for two years!) is a lot of operating leverage.

[Viking]

Mrazul, thanks for the clarity. Do you know if there has been a reporting change for Q1 for the banks on this topic?

 

Onyx1, yes, that exchange (expenses remaining at $53 billion through 2020)  is music to existing shareholders ears. I think general investors are missing the size of the cost savings that technology and the move to mobile banking is starting to provide the big banks. This will be another lever to allow them to deliver growing profitability. Economy of scale has to matter when it comes to winning in digital and it takes many years to execute. BAC looks very well positioned.

[marazul]

Viking, there has been an accounting change. Now financial institutions that hold assets without fixed payouts and maturities (i.e. equities) are forced to mark to market these assets and the delta in price between quarters goes through the p&l...used to be that these assets could be held to maturity and they wouldn´t be marked to market, wouldn´t affect book value of equity and wouldn´t go through the p&l...that changed starting January 2018...For bonds, they just have to be marked to market, but changes in price don´t flow through the p&l...so nothing changes here...Most of the securities portfolio of banks is short term investment grade bonds, so no major impact here...People are worried now because we have experienced many years of TBV per share growth as rates kept falling and banks bought stock at very low multiples, thas is no longer the case...but the reality is that none of these changes impacts the real value of banks, it´s just accounting...US banks are doing just fine

[Cigarbutt]

I think general investors are missing the size of the cost savings that technology and the move to mobile banking is starting to provide the big banks. This will be another lever to allow them to deliver growing profitability. Economy of scale has to matter when it comes to winning in digital and it takes many years to execute.

 

Disclosure:

-Fascinated by the banking industry but not invested now (for a variety of reasons).

-I accept that bank stocks may do well.

 

Polite question:

 

If you assume that information technology has and will increase "productivity" of banking, then why has the share of compensation to the finance industry to GDP ratio has risen significantly since the mid 1990's?

 

I'm asking because, in another life, when was making decisions on the relevance of introducing information technology projects, the goal was to lower cost and/or to increase revenue at the expense of a competitor.

 

The question is about sustainability of part of the moat that has characterized the banking industry. Maybe, I'm missing something.

 

[Viking]

 

Polite question: If you assume that information technology has and will increase "productivity" of banking, then why has the share of compensation to the finance industry to GDP ratio has risen significantly since the mid 1990's?

 

 

Cigarbutt, i have not looked in detail but my guess is compensation expense at BAC has come down significantly over the past 5 years. There was a short term spike as the big banks hired people to comply with all the new regulations. All the big banks have been aggressively cutting compensation expense the past few years and they all will be growing top line much faster than bottom line expenses in the coming years. (The exception is WFC who is having to ramp up expenses to comply with all the orders they are getting from the Fed.) So I would expect the ratio you reference above to be coming down and to continue lower in the coming years.

 

I look at what it costs me to manage my investments versus 10 years ago and it is significantly less. I used to pay $300 and more to simply execute a trade. Now it costs me $10. I can now hold assets in US dollar accounts and this greatly reduced the need to convert currencies which was very expensive (just need RBC to add the feature to RESP). And when I do convert currency the fees today are much lower than in the past. Given the size of my portfolio, I pay no fees when I pull $ out of one of my accounts. I also have access to high quality research. I also have a no fee checking account (do not pay for cheques, am allowed electronic transfers). The finance industry is making way less $ off of me and my family than they did 10 years ago. :-)