BAC-WT - Bank of America Warrants

[xazp]

I've done some work on this issue because I think it will be a major driver for earnings at some point. 

 

So Q3, they're showing 936,000 60+ day delinquencies and that's costing them $3Bn/quarter or $12Bn/year, or call it $14,000/delinquency.

Earlier comments suggest that normalized is 300,000 delinquencies that will cost them $500MM/quarter, or $2Bn/year.  Call that $6,000/delinquency. 

 

In other words, two pieces are elevated - both the number of delinquent customers AND the servicing cost per customer. 

 

Here's where my conjecture comes in.  I believe the foreclosure settlement mandated some expensive items need to be completed in 2012.  And I think that's why you see the cost per delinquency more than double the "normalized" rate.  Thus I think in Q1 or Q2 2013 you will see a major drop in LAS expenses, because (assuming they're following the settlement) some expensive components will be done. 

 

So I view it as a slow drop in general (as they go through the pipeline), but a fast drop sometime early next year as their expenses per delinquency drops rapidly. 

 

I don't know this for a fact, it's just my piecing together of various comments and what I've read about the foreclosure settlement. 

 

 

 

From the Q&A -- LAS will largely come down to normalized quarterly expense level by FYE 13:

 

emphasis added:

 

Brennan Hawken - UBS: Just to make sure I understood, Brian, I think you had said that, as far as the trajectory of the decline in expenses overall for the – looking at the entire thing at LAS and taking a step back, moderate improvements in 2013, but the big lever there is 2014, is that right or am I reading too much into that?

 

Brian T. Moynihan - CEO: I think I was saying that, you'll get the improvements sort of on a quarterly basis all through '13, and in '14, you have the run rate of all that accumulated for you in year-over-year comparisons, but it's going to come all during '13, so it's not moderate.

[ERICOPOLY]

I've done some work on this issue because I think it will be a major driver for earnings at some point. 

 

So Q3, they're showing 936,000 60+ day delinquencies and that's costing them $3Bn/quarter or $12Bn/year, or call it $14,000/delinquency.

Earlier comments suggest that normalized is 300,000 delinquencies that will cost them $500MM/quarter, or $2Bn/year.  Call that $6,000/delinquency. 

 

In other words, two pieces are elevated - both the number of delinquent customers AND the servicing cost per customer. 

 

Here's where my conjecture comes in.  I believe the foreclosure settlement mandated some expensive items need to be completed in 2012.  And I think that's why you see the cost per delinquency more than double the "normalized" rate.  Thus I think in Q1 or Q2 2013 you will see a major drop in LAS expenses, because (assuming they're following the settlement) some expensive components will be done. 

 

So I view it as a slow drop in general (as they go through the pipeline), but a fast drop sometime early next year as their expenses per delinquency drops rapidly. 

 

I don't know this for a fact, it's just my piecing together of various comments and what I've read about the foreclosure settlement. 

 

 

 

From the Q&A -- LAS will largely come down to normalized quarterly expense level by FYE 13:

 

emphasis added:

 

Brennan Hawken - UBS: Just to make sure I understood, Brian, I think you had said that, as far as the trajectory of the decline in expenses overall for the – looking at the entire thing at LAS and taking a step back, moderate improvements in 2013, but the big lever there is 2014, is that right or am I reading too much into that?

 

Brian T. Moynihan - CEO: I think I was saying that, you'll get the improvements sort of on a quarterly basis all through '13, and in '14, you have the run rate of all that accumulated for you in year-over-year comparisons, but it's going to come all during '13, so it's not moderate.

 

You are putting something together well into words that I have been sensing as well.  I am quaking with greed, which is odd because I had the same feeling last year and we're quite a ways into this already.

[Parsad]

I've done some work on this issue because I think it will be a major driver for earnings at some point. 

 

So Q3, they're showing 936,000 60+ day delinquencies and that's costing them $3Bn/quarter or $12Bn/year, or call it $14,000/delinquency.

Earlier comments suggest that normalized is 300,000 delinquencies that will cost them $500MM/quarter, or $2Bn/year.  Call that $6,000/delinquency. 

 

In other words, two pieces are elevated - both the number of delinquent customers AND the servicing cost per customer. 

 

Here's where my conjecture comes in.  I believe the foreclosure settlement mandated some expensive items need to be completed in 2012.  And I think that's why you see the cost per delinquency more than double the "normalized" rate.  Thus I think in Q1 or Q2 2013 you will see a major drop in LAS expenses, because (assuming they're following the settlement) some expensive components will be done. 

 

So I view it as a slow drop in general (as they go through the pipeline), but a fast drop sometime early next year as their expenses per delinquency drops rapidly. 

 

I don't know this for a fact, it's just my piecing together of various comments and what I've read about the foreclosure settlement. 

 

 

 

From the Q&A -- LAS will largely come down to normalized quarterly expense level by FYE 13:

 

emphasis added:

 

Brennan Hawken - UBS: Just to make sure I understood, Brian, I think you had said that, as far as the trajectory of the decline in expenses overall for the – looking at the entire thing at LAS and taking a step back, moderate improvements in 2013, but the big lever there is 2014, is that right or am I reading too much into that?

 

Brian T. Moynihan - CEO: I think I was saying that, you'll get the improvements sort of on a quarterly basis all through '13, and in '14, you have the run rate of all that accumulated for you in year-over-year comparisons, but it's going to come all during '13, so it's not moderate.

 

Sounds about right to me.  If that is the case, I hope they buy back shares like crazy below tangible book in 2013...if my bet doesn't come to fruition!  ;D  Cheers!

[hyten1]

eric how did you get 3.03? warrant B is trading at 3.67 right now

 

 

Let's say there are 70 cents of dividends missed by Jan 2015 if you hold the $10 strike calls. 

 

So the 2015 $10 strike call option really costs you 1.85+.70 = $2.55 per share.

 

I think somebody a while back used an optimistic yet achievable assumption to conclude the class A warrant could get down to a $10 strike by 2019 and with a per-share conversion adjustment of 1.2x.

 

Summary:,

CALL OPTION:  $2.45 

WARRANT:  effectively a $10 strike 2019 call option priced at $3.03

 

So, for next 4 years you would effectively be "borrowing" $10 per share for a total additional cost of 58 cents.  That's like 1.5% annualized interest rate for 4 years -- interest payable upfront.

 

Now, this depends entirely on how good the dividend payouts turn out to be... but it seems like a 30 cent dividend for 2013 seems entirely doable, then 40 cents in 2014, 50 cents in 2015, 60 cents per year after that.  It gets me down to about $10.50 per share on the warrant by 2019 -- I'm not sure if that's 1.2x conversion though.

 

Anyways, the warrants are starting to be attractive for sure.

[QLEAP]

you are receiving 20% more shares with each warrant

 

eric how did you get 3.03? warrant B is trading at 3.67 right now

 

 

Let's say there are 70 cents of dividends missed by Jan 2015 if you hold the $10 strike calls. 

 

So the 2015 $10 strike call option really costs you 1.85+.70 = $2.55 per share.

 

I think somebody a while back used an optimistic yet achievable assumption to conclude the class A warrant could get down to a $10 strike by 2019 and with a per-share conversion adjustment of 1.2x.

 

Summary:,

CALL OPTION:  $2.45 

WARRANT:  effectively a $10 strike 2019 call option priced at $3.03

 

So, for next 4 years you would effectively be "borrowing" $10 per share for a total additional cost of 58 cents.  That's like 1.5% annualized interest rate for 4 years -- interest payable upfront.

 

Now, this depends entirely on how good the dividend payouts turn out to be... but it seems like a 30 cent dividend for 2013 seems entirely doable, then 40 cents in 2014, 50 cents in 2015, 60 cents per year after that.  It gets me down to about $10.50 per share on the warrant by 2019 -- I'm not sure if that's 1.2x conversion though.

 

Anyways, the warrants are starting to be attractive for sure.

[Parsad]

For those that haven't listened to the Q3 BAC Conference Call, I highly recommend it.  Probably one of the best banking and financial conference calls I've ever listened to...a real lesson in banking!  Not terribly eloquent, but these guys know their business and have completely changed the business, culture and thought process of how this company works.  Especially impressed with CFO Bruce Thompson, who could lead the company at some point in the future.  Very, very good call...especially the Q&A!  Terrific questions too.  Cheers!

 

http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-audioarchives#fbid=4mI3wEZrC7r

[MrB]

http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-newsArticle&ID=1746326&highlight=#fbid=lBTQFzOEQm_

 

"Our focus on strengthening the balance sheet continued this quarter," said Chief Financial Officer Bruce Thompson. "We ended the quarter with record Tier 1 common capital ratio of 11.41 percent and an estimated Basel 3 Tier 1 common capital ratio of 8.97 percent, up from 7.95 percent as of the second quarter of 20121. With these gains, we have turned our attention to driving core earnings."

[berkshiremystery]

SeekingAlpha just had a some more dull article yesterday about BAC. Usually they have uniquely articles, but to me the author seems a little bit shortsighted. Doesn't he realize that BAC is like an old bottle of wine, the more you let it age, the more precious it becomes.

 

http://seekingalpha.com/article/930851-bank-of-america-s-financial-performance

 

Conclusion

 

The third quarter was disappointing. The net income numbers were horrible. Bank of America lacks the ability to adjust operating expenses to meet operating income. The decline in operating income isn't a one quarter event, it is a trend. The operating segment financial performance on a revenue basis isn't good. The short-term valuation may be a bit extended.

 

While the economic data is improving, Bank of America's operations aren't. I maintain a neutral rating for investors. Traders can look for opportunities to short-sell shares of Bank of America.

[Uccmal]

 

http://wallstcheatsheet.com/stocks/and-the-best-capitalized-bank-is.html/

 

Cheers!

 

The guy who wrote  the second article goofed on the basel 3 implementation date; 2017 not 2013.

 

 

[Arden]

Eric- the dividend adjustment isn't 1.2 X yield, but 2 X yield- and that's assuming the stock price is at the strike. If the stock price is below that, it's even higher than 2X.

 

Regarding the warrant A and its strike at 30- don't forget- the dividend adjustment is relative to the price. A cumulative dividend of 30% above threshold the strike will go down to 20 with 30 percent more shares per warrant. If BAC will trade at BV by 2019 this one can yield a lot more than all the other options, I think most investors pass this after just a look at the strike, but the adjustment matters.

[ERICOPOLY]

Eric- the dividend adjustment isn't 1.2 X yield, but 2 X yield- and that's assuming the stock price is at the strike. If the stock price is below that, it's even higher than 2X.

 

The original poster's scenario described a cumulative adjustment of 1.2x share conversion and with strike down to $10.

 

[Arden]

I think I understand - Maybe the OP meant than each adjustment is 1.2X yield. This makes sense then since the strike price will decrease by about that much with the share price in the area of 10$, but this doesn't take into account the increase in the number of share per warrant. If this is true, it should be more like 2.4x- assuming the share price at 2019 is above the strike and it doesn't increase too much in between.

 

BTW- I think I've realized why we've been given such generous adjustments. If the share price is 50% above the strike then each adjustment is only 66% of the share yield. Because the warrants were issued when the shares were above the strike it made sense to compensate the warrant holders with another adjustment. I think the scenario we're living right now where the share is so much lower wasn't taken fully into account and is in our favor.

[biaggio]

I think someone else did the following calculation but I have re did it with todays prices:

 

 

BAC Wt A  vs    common

2019 strike $13.30

Current share at $9.46          BAC wt A  $3.72

 

assume no dividend all buy back (just for sake of simplification + illustration only)

 

2019                        BAC return              WT-A return

if assume:

BAC at $13.30              +40%                -100%

BAC at $15                    +57%                  45%

BAC at $20                    +111%              +180%

BAC at $30                    +217%              +449%

BAC at $40                    +322%              +718%

 

Am I looking at it correctly?

 

i.e pretty much double your return vs common if selling at minimum of today's BV in return for potentially losing all your money if it does not sell for at least $13.30

[mysticdrew]

I think someone else did the following calculation but I have re did it with todays prices:

 

 

BAC Wt A  vs    common

2019 strike $13.30

Current share at $9.46          BAC wt A  $3.72

 

assume no dividend all buy back (just for sake of simplification + illustration only)

 

2019                        BAC return              WT-A return

if assume:

BAC at $13.30              +40%                -100%

BAC at $15                    +57%                  45%

BAC at $20                    +111%              +180%

BAC at $30                    +217%              +449%

BAC at $40                    +322%              +718%

 

Am I looking at it correctly?

 

i.e pretty much double your return vs common if selling at minimum of today's BV in return for potentially losing all your money if it does not sell for at least $13.30

 

BAC at $15 would be a negative 55% return, not a positive one since the value in this example would be $1.70 where as you paid 3.72, so you end up losing money.

[ERICOPOLY]

I think I understand - Maybe the OP meant than each adjustment is 1.2X yield. This makes sense then since the strike price will decrease by about that much with the share price in the area of 10$, but this doesn't take into account the increase in the number of share per warrant. If this is true, it should be more like 2.4x- assuming the share price at 2019 is above the strike and it doesn't increase too much in between.

 

BTW- I think I've realized why we've been given such generous adjustments. If the share price is 50% above the strike then each adjustment is only 66% of the share yield. Because the warrants were issued when the shares were above the strike it made sense to compensate the warrant holders with another adjustment. I think the scenario we're living right now where the share is so much lower wasn't taken fully into account and is in our favor.

 

The #.of.share.conversion adjustments merely compensate you for the otherwise lost potential of reinvesting your dividend in the stock.

 

It's a synthetic DRIP plan embedded in the warrant.  This is also why it matters not to the warrant holder if they pay dividends or buy back shares -- other than perhaps taxation on the dividend related adjustments.

[xazp]

Well this chart just shows the near-truism that if you assume your stock is going up between 40% and 300%, then leverage beats non-leverage. 

 

If you posited the same question to any number of bank analysts they'd say your return on the warrants will be between -100% and -100%.  Of course I am more partial to your chart, but, it seems to largely ignore the downsides of leverage.  Which has been the demise of plenty of smart investors. 

 

If your view is that BAC will go up between 40% and 300% with certainty, you should explore "which" type of leverage is appropriate and compare those.  For example, I personally prefer margin-based leverage, which has different pluses and minuses to the warrants.  I think a case could be made for LEAP calls too.  Not to say warrants are the wrong choice, it's just that given your assumptions of 40-300% gains, of course leverage wins, and it's only a matter of which type. 

 

 

 

I think someone else did the following calculation but I have re did it with todays prices:

 

 

BAC Wt A  vs    common

2019 strike $13.30

Current share at $9.46          BAC wt A  $3.72

 

assume no dividend all buy back (just for sake of simplification + illustration only)

 

2019                        BAC return              WT-A return

if assume:

BAC at $13.30              +40%                -100%

BAC at $15                    +57%                  45%

BAC at $20                    +111%              +180%

BAC at $30                    +217%              +449%

BAC at $40                    +322%              +718%

 

Am I looking at it correctly?

 

i.e pretty much double your return vs common if selling at minimum of today's BV in return for potentially losing all your money if it does not sell for at least $13.30

[racemize]

I just think of it in terms of break-over price, which makes that chart go to one number.  Today, BAC A warrants break-even with respect to the common is $21.99 including the lost 4 cents per year in dividends (though not reinvested).  If you think the common will be worth more than that at expiration (and are confident that it will at least be greater than ~$15), then warrants are going to do better. 

 

Wrt to vehicles for leverage, the A warrants seem to be the easiest/safest to me--I don't like the closer time horizon of LEAPs or taking on margin in my account.  I also am mostly common, these are added as a kicker for me (currently 9:1 common:warrant, though I'd like to get the warrant up a bit).

[PlanMaestro]

 

Brian Charles has been pretty decent all along

http://www.bloomberg.com/video/bank-of-america-profit-litigation-costs-ax3KLVBbRzexrc7QQLcMYg.html

[biaggio]

Well this chart just shows the near-truism that if you assume your stock is going up between 40% and 300%, then leverage beats non-leverage. 

 

If you posited the same question to any number of bank analysts they'd say your return on the warrants will be between -100% and -100%.  Of course I am more partial to your chart, but, it seems to largely ignore the downsides of leverage.  Which has been the demise of plenty of smart investors. 

 

If your view is that BAC will go up between 40% and 300% with certainty, you should explore "which" type of leverage is appropriate and compare those.  For example, I personally prefer margin-based leverage, which has different pluses and minuses to the warrants.  I think a case could be made for LEAP calls too.  Not to say warrants are the wrong choice, it's just that given your assumptions of 40-300% gains, of course leverage wins, and it's only a matter of which type. 

 

 

 

I think someone else did the following calculation but I have re did it with todays prices:

 

 

BAC Wt A  vs    common

2019 strike $13.30

Current share at $9.46          BAC wt A  $3.72

 

assume no dividend all buy back (just for sake of simplification + illustration only)

 

2019                        BAC return              WT-A return

if assume:

BAC at $13.30              +40%                -100%

BAC at $15                    +57%                  45%

BAC at $20                    +111%              +180%

BAC at $30                    +217%              +449%

BAC at $40                    +322%              +718%

 

Am I looking at it correctly?

 

i.e pretty much double your return vs common if selling at minimum of today's BV in return for potentially losing all your money if it does not sell for at least $13.30

 

Thanks for response. And thanks for correction Mystic.

 

With respect to levering, is it not wise to see how much possible upside you have for possibly losing all your bet? I think thats what I was thinking. I would be more than happy to get 300% with less down side and forget about leveraging.

[MrB]

Eric- the dividend adjustment isn't 1.2 X yield, but 2 X yield- and that's assuming the stock price is at the strike. If the stock price is below that, it's even higher than 2X.

 

Regarding the warrant A and its strike at 30- don't forget- the dividend adjustment is relative to the price. A cumulative dividend of 30% above threshold the strike will go down to 20 with 30 percent more shares per warrant. If BAC will trade at BV by 2019 this one can yield a lot more than all the other options, I think most investors pass this after just a look at the strike, but the adjustment matters.

 

"I think most investors pass this after just a look at the strike, but the adjustment matters."

[LC]

 

 

Thanks for response. And thanks for correction Mystic.

 

With respect to levering, is it not wise to see how much possible upside you have for possibly losing all your bet? I think thats what I was thinking. I would be more than happy to get 300% with less down side and forget about leveraging.

 

I agree: the majority of my BAC position is commons. However let's not forget that A-warrants are 40% cheaper than the commons. With the leverage they offer, I think they are a good way to gain additional upside exposure:

 

Let's compose three portfolios:

Portfolio 1 : 100% BAC Common

Portfolio 2: 100% BAC A-Warrants

Portfolio 3: 75% Common ; 25% A-Warrants

 

Here are the results given your assumptions:

 

2019          Portfolio A Portfolio B Portfolio C

if assume:

BAC at $13.30      40 -100         5

BAC at $15          57 -45         43

BAC at $20          111 180         128.25

BAC at $30          217 449         275

BAC at $40          322 718         421

 

If you think BAC will be above $21-22ish by 2019, holding 25% of your BAC long position in A-Warrants is a profitable endeavor.

 

[hyten1]

hmmm if BAC is at $15 wta will have a -50% return not positive

 

base on my calculation wta becomes more profitable if BAC's stock is beyond $22

 

how much do you guys BAC will be worth ultimately at $22 it will have a market cap of approx 240B

 

 

 

Thanks for response. And thanks for correction Mystic.

 

With respect to levering, is it not wise to see how much possible upside you have for possibly losing all your bet? I think thats what I was thinking. I would be more than happy to get 300% with less down side and forget about leveraging.

 

I agree: the majority of my BAC position is commons. However let's not forget that A-warrants are 40% cheaper than the commons. With the leverage they offer, I think they are a good way to gain additional upside exposure:

 

Let's compose three portfolios:

Portfolio 1 : 100% BAC Common

Portfolio 2: 100% BAC A-Warrants

Portfolio 3: 75% Common ; 25% A-Warrants

 

Here are the results given your assumptions:

 

2019          Portfolio A Portfolio B Portfolio C

if assume:

BAC at $13.30      40 -100         5

BAC at $15          57 45         54

BAC at $20          111 180         128.25

BAC at $30          217 449         275

BAC at $40          322 718         421

 

If you think BAC will be above $15.75? by 2019, holding 25% of your BAC long position in A-Warrants is a profitable endeavor.

[LC]

hmmm if BAC is at $15 wta will have a -50% return not positive

 

base on my calculation wta becomes more profitable if BAC's stock is beyond $22

 

how much do you guys BAC will be worth ultimately at $22 it will have a market cap of approx 240B

 

Thanks I updated my chart w/ the corrections.

[ERICOPOLY]

how much do you guys BAC will be worth ultimately at $22 it will have a market cap of approx 240B

 

They may have a TBV north of $27 per share by 2019 if they merely retain all earnings and sit on them (no payouts).

 

[redskin]

I don't think it is that difficult to see BAC earning $25 billion in 2019.  I'm hoping they will have their share count down to around 7.5 billion.  $3.33 eps.

 

how much do you guys BAC will be worth ultimately at $22 it will have a market cap of approx 240B

 

They may have a TBV north of $27 per share by 2019 if they merely retain all earnings and sit on them (no payouts).