BAC-WT - Bank of America Warrants

[Viking]

Now that earnings have been released we can start to think about CCAR and capital return which will be announced in late June. We will find out what  the new dividend payout will be and also the total amount for share repurchases. It really is amazing how far BAC has come in the past 24 months. What is possible/likely for BAC?

 

Analysts expect BAC to earn about $26 billion in 2018 = $2.55/share ($27.5 before paying preferred dividends of $1.5 billion). I think it is possible they will be approved to return $26 billion total (July to June).

 

Possible Dividend = $0.22/quarter = 2.9% yield = $2.2 billion per quarter = $8.8 billion per year

Payout ratio $0.88/$2.55 = 35% which is in line with Moynihan’s previous communication

 

Possible Buybacks = $26 - $8.8 = $17.2 billion / $34 per share (avg cost?) = 505 million shares

- after stock awards, expect share count to fall 4.5%

 

This would give investors 3% dividend plus 4.5% net stock repurchases = 7.5% total return

Top line will still be growing and total profits will also continue to grow.

 

Total capital return history:

2018 = $26? Billion = $8.8 billion in dividends and $17.2 billion in share repurchases

2017 = $16.8 billion = $4 billion in dividends and $12.8 billion in share repurchases

2016 = $7.6 billion = $2.5 billion in dividends and $5.1 billion in share repurchases

 

Dividend increase history:

July 2018 = $0.22?

July 2017 = $0.12

July 2016 = $0.075

 

Year end share count:

March 31 2018 = 10,176, 111 lower than Dec 31, 2017

2017 = 10,287 (includes 700 million addition in Aug 24 from BRK warrants), 465 lower than PY

2016 = 10,053, 328 lower than PY

- it looks to me like 85-90% of BAC share repurchases actually lower shares outstanding with about 10-15% offset as stock compensation.

 

At Dec 31, 2017 remaining stock repurchase authorization was $10.1 billion.

In Q1 2018, BAC returned $6.1 billion total to shareholders (dividends and repurchases)

 

Warrants still outstanding:

Oct 28 2018 = 122 million shares

Jan 16 2019 = 143 million shares

 

[onyx1]

Thanks for the post Viking. 

 

A few comments.

 

(1) BAC still has $19.4bln in DTA (net of allowances).  The 10-k doesn't offer enough information on how much or when these will be applied.  But I think it's safe to assume they will likely shelter some taxes this year resulting in a higher capital return amount than the $26bln for 2018.

 

(2) Based on recent comments, a 35% dividend payout looks optimistic.

 

 

Earnings call, January 17, 2018

 

Analyst

Okay. And then just last question on the dividend payout ratio. I realized that earnings is up with a lower tax rate. Do you expect you'll keep that dividend payout ratio flat? Or how are you thinking about the dividend and overall capital return?

 

Moynihan

We basically said we're moving towards a 30%-type payout ratio of earnings, and I think that would mathematically follow your -- what you just laid out. In fact, if tax earnings go up, it'd be a higher number. So -- but we're not quite there yet, but we're pushing that towards that direction.

Credit Suisse Conference presentation, February 13, 2018

 

Moynihan

Well, as you think -- if you look at last year with the extra $5 billion, which because of all the different demand that's happened, we pushed up the $17 billion, $18 billion -- $17 billion and change. And so you're right out there and if you annualize even the dividend for the second half. So we will push through. And so there's a lot of talk about this scenario. And the scenario is still to put you back -- essentially people said it's more severe, but you'd say take, of course, as we're getting -- the cycle is getting better and better. Unemployment is now 4. Last year, it was, I don't know, 4.5, whatever. You still view the endpoint as being a real member, not a relative number. So 500 basis point increase from 5 to 10 will be -- you still leave at 10 because that's the marker. And so that wasn't as unexpected in my mind. It's counter -- it's not. Otherwise, it'd be too procyclical. As the cycle improves, you keep bringing in the 500 basis point change, it'll be a less and less number. So we've erased that. We had $20 billion excess last year. Our risk is down. Our capital is up. The earnings power is up. The tax reform -- everybody's earnings power's up. So we'll push hard to get as much out as we can. It's the #1 issue for the company, to get the capital, because you can't do acquisitions. What is the use of capital acquisition? You need it for organic growth and then you return it to the shareholders. We're not doing any acquisitions. We don't need it for organic growth. And the reality is that we -- even with the loan growth we have in the business line, the net loan growth still doesn't stop the current capital base. And so therefore, we got $70 billion -- $60 billion, $70 billion of loans to still run off that we could replace with good loans. And then even within the good loans, we got a lot of loans like mortgage loans and stuff that we would make a different decision on if we actually needed capacity. So we've got tremendous capacity to support the customers. And so the real question is how do we return it? 30% dividends, 70% buybacks? And, we'll push through -- we'll push as hard as we can and push it north of where it is today.

 

Analyst

So where your stock is today, I would argue it's still relatively inexpensive. You said 30% dividend. As a G-SIB, are you feeling that not only the language and the instructions, but the tone of the Fed would keep you at that -- when you get to 30%, keeps you at that 30%?

 

Moynihan

I think the reality is if you go back and sort of study how do you never have to cut the dividend -- which is the goal of everybody -- those kinds of goals are sort of -- lead to this conclusion I talked about beginning 6 years ago or something. And I just believe that, that is a responsible place to be, whether it's a little higher, a little lower in a given day. But principally, and I think, with the amount of capital we have and multiples that the marker will put on the earnings, I think we'll always see good dynamics and the stock's always cheap in our minds.

 

It's not clear here, but it appears to me that the most we can expect in June is 30%, or $0.19/quarter.  Obviously, I'd be very happy if I'm wrong and you are right.

[John Hjorth]

Thank you for some awesome posts lately about BAC in this topic, gents,

 

I was absolutely stunned by the 2018Q1 performance reported by BAC monday this week - absolutely speachless, when I clicked my way into the reporting, based on a received notification by e-mail.

 

Just a few thoughts shared here, trying to add to the idea as is right now.

 

• Share buy backs: Joel [Racemize] has posted before about the math involved in these calculations. [i think it was in the C topic, not sure right now though.] I've been struggling with this, trying to model it in Excel as some kind of approximation - so far with no success, based on desk testing. I've come to the conclusion, that it must be integral calculus - a math excersise, that I haven't maintained during now about 40 years. It's just dead & non-existing inside my head. However, I don't give up here. I still have good contacts at University of Southern Denmark here in Odense, and I'm willing to use it here, for the purpose of helping us all here on CoBF. [it's about the average repurchase price per share under the share buybacks going on now and going forward, under certain conditions, in the last post by Viking in this topic indicated as "33 (?)"[<- please, take no offense here, Viking - I really appreciate all your posts about the big four US banks here on CoBF!]
  
• Share buybacks vs. expansion of business volume: Please think of a US infrastructure program here. We are talking about a lot of USD Bs here. I will personally gladly let a part [or all of it] of the BAC share buy back program go for reasonable growth in business volume, [if needed], based on a US infrastructure reform. Let's just see how it will play out going forward.
  
• Relation to FED and other regulative bodies: The environment is changing - fast - at least with regard to sentiment and perception among the involved parties. The banks are now pushing hard for a material change. Please read the shareholder letter by Mr. Dimon for JPM released some days ago, and you'll find this in it:There will be NO help from the banks, next time hell visits Earth again at some time in future. Because the banks have been punished for doing that under the GFC. - What a hardliner message! - implying: "Next time, fix it yourself, please!" - The balance of power is to me actually shifting.
  
• Operational focus: It's been keeping the nose in the track for years now, to get things turned around. Every shareholder letter from the big four US banks CEOs are about it. To just get better, and never to have a repetition of what happened nine years ago. It saturates all I have read recently.
  
• <edit>New FED boss Jerome Powell:To me, he is good for all of us. Absolutely clear in the spit. No promises, just data driven, flexible decision making going forward with regard to interest rates. We also have to remember, that the expected interest rate hikes going forward are - gradually - moving the US economy out of "unknown territory".</edit>
  

[Viking]

Onyx1, I am more comfortable with $26 billion as a target total payout and less confident in the split between dividend and share repurchase. Thanks for posting the quotes.  I think the Fed is less concerned about size of dividend and I wonder if banks will get a little more aggressive this year with the dividend and target a 3% yield (especially with bond yields moving higher). I also have read that all the big banks feel the stress test is more severe this year and I have this as a risk for lower awarded payouts.

 

John, I started at $33 as a best guess as to an average cost for shares starting in July 2018 to June 2019. In an edit I then moved to $34 as I do expect the shares to move higher later in the year. I think this will also be too low. The big benefit of shares trading lower is BAC will be able to buy back more. :-)

[racemize]

Adding in on the buybacks John, all I'm doing with my spreadsheets is assuming that the average buyback happens at a certain P/E based on the prior year's earnings, and then I change the P/E to see how the results change.  We don't have enough sig figs to pull out the precise buyback effects, so I go the easy route!

[Cigarbutt]

Apologies: realize that the following may have the effect of an open window during winter and know that this is not the best way to make friends. Won’t pursue this so just ignore if you feel this is not relevant.

 

Disclosure: was fascinated by the TARP program, looked at big bank warrants++ but did not buy them (so potential bias here).

 

The following is conceptual and historical in nature and has to do with the rear-view mirror risk.

 

The big banks survived the GFC and in fact adapted very well. Big banks balance sheets definitely look stronger.

 

For 20 years or so, the trends for the financial industry have been incredibly favorable (even accounting for the bumps along the way).

 

Some of these fundamental trends:

 

-lending volume (and standards) at both the consumer and corporate level

-evolution of the originate-to-distribute model

-intermediation getting larger, more complex and more opaque

-financial sector as a whole getting larger (revenue/profits compared to GDP)

-increasing adapatation (+/- regulatory capture?) by large banks that are getting larger

-decreasing importance of the net interest margin during financial repression

-increasing emphasis on trading and derivatives

 

Respectfully submitted, all I’m saying is that future patterns of growth and profitability assume that previous trends will continue and that may be a significant assumption.

 

Just to illustrate what I mean:

 

In 2012, McKinsey produced a very interesting report on deleveraging:

https://www.mckinsey.com/~/media/McKinsey/Global%20Themes/Global%20Capital%20Markets/Uneven%20progress%20on%20the%20path%20to%20growth/MGI_Debt_and_deleveraging_Uneven_progress_to_growth_Report.ashx

 

You don’t need to read the 64-page report. Just go to page 28, exhibit 7. For illustrative purpose of previous trends and trends to come, the authors conclude that US households are “nicely” deleveraging as the curve is going back to its long term trend. But who said that we should normally expect the household debt to disposable income ratio to rise forever?

 

I agree with Viking that the fees I pay to banks in terms of % of assets have come down and realize that “they all will be growing top line much faster than bottom line expenses in the coming years" . So, I’m just trying to reconcile the two. Maybe, I'm the patsy.

 

Again, apologies to all and I will shut up on this topic from now on.

 

 

[racemize]

Ultimately, I think it comes down to whether banking is a good business when it is run well.  I would submit that it is.  If you can take money at one rate, and lend it out at a higher one, and have a decent ROE, then returns should be generally around that ROE. 

 

Currently, fixed costs are dropping as the tech allows branches to drop and scale helps.  I think that helps offset the higher levels of capital needed.

[HalfMeasure]

Apologies: realize that the following may have the effect of an open window during winter and know that this is not the best way to make friends. Won’t pursue this so just ignore if you feel this is not relevant.

 

Disclosure: was fascinated by the TARP program, looked at big bank warrants++ but did not buy them (so potential bias here).

 

The following is conceptual and historical in nature and has to do with the rear-view mirror risk.

 

The big banks survived the GFC and in fact adapted very well. Big banks balance sheets definitely look stronger.

 

For 20 years or so, the trends for the financial industry have been incredibly favorable (even accounting for the bumps along the way).

 

Some of these fundamental trends:

 

-lending volume (and standards) at both the consumer and corporate level

-evolution of the originate-to-distribute model

-intermediation getting larger, more complex and more opaque

-financial sector as a whole getting larger (revenue/profits compared to GDP)

-increasing adapatation (+/- regulatory capture?) by large banks that are getting larger

-decreasing importance of the net interest margin during financial repression

-increasing emphasis on trading and derivatives

 

Respectfully submitted, all I’m saying is that future patterns of growth and profitability assume that previous trends will continue and that may be a significant assumption.

 

Just to illustrate what I mean:

 

In 2012, McKinsey produced a very interesting report on deleveraging:

https://www.mckinsey.com/~/media/McKinsey/Global%20Themes/Global%20Capital%20Markets/Uneven%20progress%20on%20the%20path%20to%20growth/MGI_Debt_and_deleveraging_Uneven_progress_to_growth_Report.ashx

 

You don’t need to read the 64-page report. Just go to page 28, exhibit 7. For illustrative purpose of previous trends and trends to come, the authors conclude that US households are “nicely” deleveraging as the curve is going back to its long term trend. But who said that we should normally expect the household debt to disposable income ratio to rise forever?

 

I agree with Viking that the fees I pay to banks in terms of % of assets have come down and realize that “they all will be growing top line much faster than bottom line expenses in the coming years" . So, I’m just trying to reconcile the two. Maybe, I'm the patsy.

 

Again, apologies to all and I will shut up on this topic from now on.

 

I don't necessarily disagree with any of your comments, but I would add a few on the other side of the equation. The banking sector is currently as profitable as it is despite the flattest yield curve we've seen since 2007 - banks borrow short and lend long so the 10-2 spread is a good proxy and at 44bps the spread is meager. There's no incentive for credit formation on the part of the banks when the spread is this low, and I think that has put a lid on loan growth in recent quarters. I would argue that the sector is also less competitive than it has been in the past due to a wave of consolidation during and post the GFC. Further, I think that all the regulation on the back of the GFC has actually dampened competition by tapering how aggressively banks can be managed and by increasing the barriers to entry due to increased regulatory/compliance costs. And in the past, one of the reasons banks traded at a discount to the market on a P/E basis was because of the inherent risk from being 25-30x levered - this risk profile has come down drastically yet I believe the market is still scarred by memories of the GFC and hasn't really "re-rated" the sector for the pro-forma risk profile. Even without some of the secular tailwinds of the past cycles, banks look attractive here even at ~GDP growth.

[John Hjorth]

The Economist - Dollars and sense - Finance and Economics [May 3^rd 2018]: Make Bank of America great again.

 

- - - o 0 o - - -

 

I'm now in need of new white T-shirt with the text "MBoAGA" and the BAC logo!

[Viking]

Nice summary of why bank stocks should do well over the next few years; lots of tailwinds.

 

“Investors should go overweight in financial stocks, especially banks, based on seven trends, according to Goldman Sachs Group Inc. (GS).”

1.) rising interest rates

2.) increased returns of capital to shareholders

3.) continued deregulation

4.) strong M&A advisory fees

5.) improving net interest margins

6.) loan growth

7.) attractive valuation and growth

 

Read more: 8 Bank Stocks to Lead the Market in 2018: Goldman | Investopedia https://www.investopedia.com/news/8-bank-stocks-lead-market-2018-goldman/#ixzz5F8NSaKcw

Follow us: Investopedia on Facebook

 

 

https://www.investopedia.com/news/8-bank-stocks-lead-market-2018-goldman/?partner=YahooSA&yptr=yahoo

[John Hjorth]

CNBC [Today]: Trump signs the biggest rollback of bank rules since the financial crisis.

 

To me, it reads like the Big Four US banks do not get any regulatory ease - this time.

[Viking]

CEO of BAC spoke for 50 minutes at the Bernstein Conference today:

- http://investor.bankofamerica.com/phoenix.zhtml?p=irol-eventDetails&c=71595&eventID=5271798#fbid=dJ132liOj51

 

My key takeaways:

1.) I think investors do not understand how much technology is lowering costs at BAC. This is allowing BAC to invest in their business ($3 billion technology spend), grow revenue and keep expenses flat (growing total profits). Positive operating leverage. They are still early in this virtuous cycle.

2.) BAC is very proud of their underwriting; they feel they are more conservative than peers (said look at CCAR stress test results for proof).

3.) NII: regarding repricing as rates rise, BAC has a big advantage versus peers due to their consumer franchise (1/2 of deposits are chequing accounts and do not reprice).

4.) Dividend payout will be moving closer to 30% of earnings

5.) Regulatory relief is coming; timing is unknown.

 

Notes:

- positive operating leverage for 13 straight quarters (revenue growing faster than expenses); will continue moving forward. 

- US consumer spending over first 5 months is very robust (up 10%) and stronger than year ago (6%)

- if US consumer is spending US economy will do well; this will drive global economy

- Moynihan is very proud of their risk management; feels underwriting is more conservative than peers; this is reflected in CCAR stress test where BAC is lowest among peers.

- Operating leverage comments: They have 25% fewer managers over past 3 years. Technology is reducing costs. Started in 2011, today 50% of all cheques are deposited by taking a picture (not visiting a branch). Erika was just rolled out. Fewer branches; more sales people.

- Net Interest Income: currently growing similar to last year, by about $500 million per quarter (compared to last years quarter). Should increase $2 billion this year. Seeing solid deposit growth. 1/2 of consumer deposits are chequing accounts where reprising will be minimal; big advantage to peers at this stage in the cycle.

- trading -flat to PY

- investment banking - in line with fee pool trends

- branch build outs in Denver and Minneapolis going very well; started 3 years ago.

- retooling existing branches

- spending $3 billion per year on technology; cyber security spend in $700 million

- BAC capital levels is far in excess of what it needs to be; currently have $15-$20 billion in excess capital; eventually this will be returned to shareholders; will take time to get it out.

- it was only starting Q4 of last year that BAC started returning 100% of earnings to shareholders (capital had been building previously).

- regularly changes coming will be helpful; only question is timing (they are coming just do not know the timing)

- ROTCE is up to 14.6%; need to get rid of extra capital :-)

- dividend: will push up to a 30% payout

- buybacks: stock is still cheap

- regulatory relief wish list: 1.) capital deployment: what to do with excess capital 2.) simplify regulation (too much complexity). Referenced White Paper by Mnuchin and Phillips for what will be coming (timing is not known).

[John Hjorth]

Thank you again for sharing your thoughts and notes on BAC, Viking,

 

So far - as I see things - your thesis from pre CCAR 2017 Announcements has played out very, very nicely for at least three of the Big Four US banks.

 

The more I think of it, the more I come to the conclusion, that BAC - despite the increase in share price since last BAC CCAR  Announcement - is actually cheaper now than it was about 11 months ago pre CCAR Announcement in June 2017, if one more or less subjective weigh in all the developments since then.

 

I think of it in relation to especially operational leverage as defined by you in your last post, where I sense a move to focus on running the bank efficiently going forward, where the bank seemed to have come out the legacy mud related to the GFC past. 2018Q1 was impressive.

 

- - - o 0 o - - -

 

Your notes here on CoBF in your last post contains a signal about BAC dividends from Mr. Moynihan about a wish to the FED about dividend increases to 30 percent of profits going forward. [i'm sure, FED is listening, too.] We could both speculate about the share buyback asked for by BAC to FED between 2018 CCAR and 2019 CCAR, as well [or bad] as I could.

 

My question is more in the direction : Based on the contents of the conference, do you think that BAC will ask for permission to actually increase its buyback program [perhaps materially] between CCAR 2018 and CCAR 2019? [i know, the qustion as such is speculative in it's nature - It's actually for my part not meant that way. More in the direction : "If we [bAC] don't ask [for "enough"], we don't get the permission." vs. "We don't try to strech it too far, or the FED will deadlock."

 

Somehow, it seems to me to be a combination of "state your "case" [and your arguments], based on your facts, as presented to us", combined with a [highly] psychological based bargaining situation, with one part [the FED] having the power to rule and decide. [The bargaining environment perhaps getting more collaborative than a year ago, though.]

[Viking]

John, thanks for taking the time to post... nice to get a discussion going.

 

A.) “The more I think of it, the more I come to the conclusion, that BAC - despite the increase in share price since last BAC CCAR  Announcement - is actually cheaper now than it was about 11 months ago pre CCAR Announcement in June 2017, if one more or less subjective weigh in all the developments since then.” R

 

John, I agree with this statement. In the past 12 months BAC has grown total profits, significantly reduced diluted share count and had their tax rate significantly reduced. This will result in earnings per share growth of close to 40% for 2018 (from about $1.80 to $2.55). That was what we saw when BAC reported in Q1 and it should continue. The stock was trading around $23 a year ago so it is up a little more than 25%.

 

My guess is many investors are anchored and valuing BAC based on training earnings; if you look at Yahoo Finance it says BAC has earned $1.72/share in the past 12 months and currently trades at a PE of 17. Perhaps this looks expensive to investors. (Trailing earnings is understated significantly due to the one time hit BAC took in Q4 2017 because of tax reform.) BAC will earn about $2.55/share in 2018 so when they report year end results in Jan 2019 (7 short months away) Yahoo Finance will show a PE of 11.6 (assuming the stock is still trading at $29.50).

 

The story for the big US banks has improved considerably over the past 12 months:

1.) top line growth is solid

- Growth in he US economy has accelerated and is expected to be close to 3% in 2018.

- US consumer is spending more and employment continues to grow nicely.

- The Fed is expected to raise rates 3 times in 2018 which will increase NII.

- The benefits of tax reform will flow through to the economy in the back half of 2018 and 2019. Citi CEO said yesterday that the focus is on the drop in rates but the change in the territorial rules will also have a significant impact on investment in the US (something Citi understands very well given their international operations).

 

2.) costs continue to come down:

- The big banks should see some regulatory relief (leading to cost savings) in back half of 2018 and 2019.

- Investments in technology are significantly lowering their cost base.

 

3.) Balance Sheet:

Capital return is increasing (resulting in even higher dividends and share repurchases).

- The banks remain overcapitalized and it will take many years of capital returns in excess of earnings to deal with this ‘problem’.

 

4.) Competition:

Their European competitors are still weak (I.e. Deutsche Bank).

 

5.) summary

- higher revenue + flat expenses + 5% lower share count = much higher EPS

- 15% EPS growth in 2019 looks pretty doable. Pretty solid growth after 40% eps growth in 2018.

- Chug, chug, chug :-)

 

B.) “My question is more in the direction : Based on the contents of the conference, do you think that BAC will ask for permission to actually increase its buyback program [perhaps materially] between CCAR 2018 and CCAR 2019?”

 

John, the BAC CEO has pretty clearly stated that they hold $15-$20 billion in excess capital (over any buffers they need). It was only in Q4 of 2017 that BAC returned 100% of earnings; up until then they had been building capital. BAC will earn around $25.5 billion in 2018 and around $27.5 in 2019. If they are not approved to return $26 billion in June (for the July 2018- June 2019 CCAR cycle) they will still be adding to capital. A $26 billion award also does not address the $15 billion in excess capital.

 

My guess is BAC will be approved to return a minimum of $25 billion in June for CCAR. I think the dividend will increase to $0.18 from $0.12. With around 10 billion diluted shares outstanding total paid for dividends = $7 billion. This will leave $18 billion for share repurchases. With shares trading at $35 (let’s be optimistic) this would allow BAC to retire 500 million or about 5% of shares outstanding. At some point BAC will need capital return of +$30 billion per year but perhaps this will wait until June 2019 CCAR. Moynihan said very clearly that the excess capital will be coming back to shareholders... he was just uncertain on the timing.

 

I continue to believe that the story for big US bank stocks continues to get better. I think the big bank stocks are cheap and patient investors will be rewarded with solid returns over the next couple of years. (I have no idea where the bank stocks will trade in the next week, month etc. But Buffett has said that for companies doing large share buybacks long term investors should hope for a depressed share price and this is how I am thinking at present.)

[Spekulatius]

I don’t think that BAC is that cheap here. Tangible book is $17/ share, while the share ate $30, so this is about 1.75x tangible book here. They need to do 15% ROE over the cycle to justify the share price.

 

I actually think their valuation is close to JPM now. Both BAC and JPM CETC1 ratio is about 11.5%/11.8% and those values have been sliding down a little over the years. That is actually lower than most European banks. DB’s CETC1 ratio is ~13.4% and LYG’s ~14%. Of course the US banks have profitability going for them, while DB is hovering about breakeven and the English banks still have legacy issues (PPI, fines) to deal with (LYG less, BCS more).

 

BAC has over the years narrowed the gap towards JPM quite a bit and I think they can almost match them in terms of ROA and risk. I do think that buying back stock and reducing the capital base at 1.75x (BAC) or 2x tangible book is short sighted. I am aware of the stress test results and they both pass,  but I think these models don’t take into account the reflexivity that is inherent with banking. Just look at the perception that DB is having right now despite solid capital buffers.

[Viking]

I don’t think that BAC is that cheap here. Tangible book is $17/ share, while the share ate $30, so this is about 1.75x tangible book here. They need to do 15% ROE over the cycle to justify the share price.

 

I actually think their valuation is close to JPM now. Both BAC and JPM CETC1 ratio is about 11.5%/11.8% and those values have been sliding down a little over the years. That is actually lower than most European banks. DB’s CETC1 ratio is ~13.4% and LYG’s ~14%. Of course the US banks have profitability going for them, while DB is hovering about breakeven and the English banks still have legacy issues (PPI, fines) to deal with (LYG less, BCS more).

 

BAC has over the years narrowed the gap towards JPM quite a bit and I think they can almost match them in terms of ROA and risk. I do think that buying back stock and reducing the capital base at 1.75x (BAC) or 2x tangible book is short sighted. I am aware of the stress test results and they both pass,  but I think these models don’t take into account the reflexivity that is inherent with banking. Just look at the perception that DB is having right now despite solid capital buffers.

 

Spekulatius, thanks for sharing your thoughts. Currently, I think BAC is still cheap. Not crazy cheap like it was in mid 2016. The problem when trying to value the company is there is simply too much noise (too much stuff going on that makes it difficult to understand what their true profitability is etc).

- tax reform significantly understates last years reported earnings

- they are still dealing with legacy issues (I think their runoff portfolio is something like 70 billion and this is still muting reported growth; crazy that 2007-08 crisis is still not behind them

- regulation will be changing; but like tax reform last year until it is done it is too hard to build into the numbers

- where are we in the economic cycle? Dimon suggested perhaps the 6th inning of a 9 inning game which suggests we may have 3 or 4 years left in the expansion

- technology: how much will it lower costs in the coming years? Citi CEO said two days ago their expense ratio would be falling from 58 to 57% this year, to 55% in 2019 and 53% in 2020. If this is true these are extremely large reduction and this will drive significant increases in earnings.

 

Here is how I am looking at BAC’s valuation (in a very simplistic way). f you apply current tax rules to last years earnings my guess is they would have earned about $2.20 per share. After Q1 rolling 12 month earnings were about $2.25-$2.30. My guess is shares are currently trading at about a 13PE to normalized trailing earnings. My guess is they will be able to grow earnings per share by 15% per year moving forward for the next couple of years. This puts the PEG under 1 which looks pretty good to me. Note, i will be happy with 10% return off my BAC position but including dividend my guess is I will get closer to 15% return. Bank stocks are very different animals than they have been in the past; my guess is over time Mr Market will come to love them again (and bid them up to a lofty valuation). At that time I will be happy to sell high and move on. :-)

[topofeaturellc]

While I mostly agree with the comments re cheapness etc, don’t get caught on Basel #s.  Risk weighting’s are the main driver of the variance relative to Europe.

[Spekulatius]

While I mostly agree with the comments re cheapness etc, don’t get caught on Basel #s.  Risk weighting’s are the main driver of the variance relative to Europe.

 

Could you elaborate on thr differences in risk weighting between European and US banks. I thought these are now standardized, as well as the CETC1 ratio.

[Rasputin]

There are a lot of published papers on this issue.  There many factors for the difference, but mainly, European banks (UK included) are allowed to use internal modelling without a floor (as a percentage of standardized).  Our banks had the Collins amendment of Dodd Frank that put 100% of standardized RWA as the floor.  You can quickly check US banks' CET1 vs their leverage ratios and European and UK banks CET1 vs their leverage ratios.  Also check banks rwa intensity ratio (rwa as % of total asset)

 

 

[John Hjorth]

Good to see you back, Rasputin,

 

Are you still very heavy BAC?

[Rasputin]

Hi John,

 

Yes, BAC is still my top holding, though new money is going to WFC.

[John Hjorth]

I'm sorry for taking so long to get back with a reponse to your posts here, Viking,

 

Please just consider it a fact, that I'm a slow catcher. To me, your posts are so dense [here meant in a really positive way], that they - simply put - generate a lot of homework to do, to be able understand all details and shades of your comments. It's for me actually sentense-by-sentence work. [ : - ) ]

 

I was actually myself a bit suprised - in a positive way - by reading your BAC capital return calculations and expectations contained in your post #7239. I was actually also a bit skeptical about it, thinking "Can this really be true [in the meaning: "likely"]?"

 

It turns out that I had not taken the excess capital already built up so far into consideration in what on a loose basis was going on inside my head.

 

Your comments about "the noise" in the financials for BAC at this point in time all appear valid to me, too. I have also noted, that they almost all point in the direction for the better going forward [, though perhaps legacy assets might end up being an exception here - time will tell].

 

While I was trying to get some perspective on my own personal anchoring, I found: Forbes [June 29^th 2017]: Bank of America Will Return Nearly $17 Billion To Shareholders Over The Next Four Quarters. The table in the article combined with the contents of the article to me explains it quite well over time.

 

Inside my head I actually picture it like BAC coming out of a straitjacket after being constrained for a long time, but based on general good behavior while constrained.

 

It sure will be interesting to read the CCAR Announcements for all the Big Four US banks end of this month. I will not be as surprised as I was last year, if we experience a bit more than USD 25 B for BAC, though. [ : - ) ]

 

- - - o 0 o - - -

 

Furthermore, from my personal point of view, being an European citizen with an [obscure] functional currency pegged to the EUR: Recent events here in Europe within the last few weeks has made it clear to me, how far away ECB is in the process of a gradual rollback of QE to start raising interest rates in Europe, while general consensus for US interest rates is that they will gradually increase, unless something unforeseen and bad with US economy may happen. [it may happen.] So I also expect the USD/DKK pair to improve to my advantage.

[Spekulatius]

The low interest rates in the EU are one , if not the most significant reason why European banks are lagging. I am no t sure if the EU can afford to raise interest rates either, with Italy having problems again and the EU central bank being run by and Italian.

 

Then there is the issue with capitalization, if you just take tangible capital / total assets (and ignore RWA/models J entirely, the big US banks tend to have rations around 9%, while the European banks are around 5% (~6% for ING, ,4.7% (?) for DB), which is a pretty significant difference. Then European banks can maybe at best generate 10% ROE, while US banks can do 15% ROE  -;so this pretty much explains the valuation differential.

 

I think British banks may have a better chance to recover their profitability due to Brexit as NIM are already better than in the EU, but they still have to work through legacy issues (PPI, fines and restructuring in case of BCS).

 

Thanks a lot to Rasputin for his helpful input.

 

[Viking]

John, regarding capital return, the analyst community is starting to release their estimates of what each of the banks will be approved to return for the 2018-19 cycle. RBC is estimating BAC will be approved to return a total of $26.5 billion (dividend plus total stock repurchases). RBC is estimating the dividend to increase to $0.22/share/quarter (given Fed is now allowing payout ratios over 30%); but I think this is too high for this year (current dividend is $0.12).

 

In the 2017-18 cycle BAC was approved to return $21.6 billion ($16.6 billion initial award plus $5 billion addition in Dec). The $16.6 billion initial award was $12 billion for share repurchases + $0.9 billion for new share issuance + dividend.

 

For BAC I find it is challenging to marry CCAR numbers (July to June) to their quarterly and annual reporting (Jan to December).

 

For BAC, the warrants also add complexity. In 2017 when Buffett exercised the BAC warrants held by Berkshire it added 700 million shares; if you look at year end share count for BAC it looks like they are adding shares (compared to the other big banks who are shrinking share count). Investors need to look at diluted shares outstanding for BAC to understand what they are accomplishing with the buybacks. Fortunately, the last of the warrants will convert later this year and in 1H next year. This will get diluted shares close to reported outstanding shares. This will make the financials easier to understand for BAC and I think that will help with the valuation.

 

Regarding currency, living in Canada, I can relate somewhat to your thinking. I think that what Trump is doing is very good for the US and companies with operations in the US. I think people are underestimating how strong the US economy will be moving forward (GDP growth may accelerate in 2H 2018 to over 3%). Unfortunately, smaller economies that have grown dependent on the US (like Canada) will likely experience a more challenging environment moving forward. At the same time, here in Canada, both federally and provincially the new governments that have been elected recently are increasing spending, raising taxes, raising minimum wages, and increasing regulation (the opposite of what Trump is doing); on balance this will also make it more difficult to complete with the US (they are moving in one direction and we are moving in the other). My guess is, the Canadian economy will be underperforming the US in the coming years; in turn my guess is the CAN $ will weaken versus the US $ in the coming years. So I am happy to own US stocks, like BAC, as a hedge.

[Viking]

The low interest rates in the EU are one , if not the most significant reason why European banks are lagging. I am no t sure if the EU can afford to raise interest rates either, with Italy having problems again and the EU central bank being run by and Italian.

 

Then there is the issue with capitalization, if you just take tangible capital / total assets (and ignore RWA/models J entirely, the big US banks tend to have rations around 9%, while the European banks are around 5% (~6% for ING, ,4.7% (?) for DB), which is a pretty significant difference. Then European banks can maybe at best generate 10% ROE, while US banks can do 15% ROE  -;so this pretty much explains the valuation differential.

 

I think British banks may have a better chance to recover their profitability due to Brexit as NIM are already better than in the EU, but they still have to work through legacy issues (PPI, fines and restructuring in case of BCS).

 

Thanks a lot to Rasputin for his helpful input.

 

Thanks for offering a solid explanation for why the European banks trade at a much lower multiple to the US banks.

 

I find it very interesting to look at how countries handle their crises. Like or not like the US model it certainly is resilient. Post 2008 the US economy went through a terrible recession and many people lost everything; especially those with low income. Fast forward 10 years and, after taking some pretty bitter medicine, the US economy is rolling once again. Other countries take a much more compassionate approach; they do not want unemployment so struggling companies are not allowed to fail etc. Unfortunately, sometimes this results in decades long issues. I am not an expert on Japan but they have had economic issues for decades now. I am not saying one approach is better than another; they all have their trade offs :-)