BAC-WT - Bank of America Warrants

[Guest Dazel]

 

 

BAC cost of capital is higher than WFC because of the long term debt of country wide and Merrill...these will run off with time but more legacy high cost of capital is parpt of the hand "new Bac was handed"

 

The market is saying we want to see it happen...all of what we assume will improve at "New Bac" over time...lawsuits, cost of capital, regulatory issues, business plan etc...

 

And then Europe pops up....and then china pops up and the market sees another crisis...so stock drops are two fold:

 

1. Is the New Bac working?

2. A bankruptcy of the Pigs will cause a crisis.

 

The frustrating part is they have no control over Europe and the market is terrified by it.

 

We have traded the stock...bought options $10 options at $6 range sold them..

 

We have only held common stock since then and again traded  noting $10 has been a barrier the market is unwilling to pay for.

 

To us short term europe is the issue...we watch bond yields there closely...they are 90% correlated to the price of Bac stock....like it or not this is the case...any type of resolvement there is the key to Bac confidence.

 

We agree everyone is right in the long term..but in order for 1. To be recognized 2. Has to be stable...so getting the timing right is extremely tough. Return of capital will help but again that is down the road.

Dazel.

[bmichaud]

Anyways, I sleep very poorly some nights.  Only, it's not for the reasons you might think.  If you have young children, you could replicate this by telling them that Santa is coming... only tell them you don't know which night he's coming.  They'll be up every night waiting.

 

Great analogy Eric!  But try and get some sleep, since you know you won't be able to see which night Santa comes anyway...plus it will happen in the day before markets open with a press release.  Cheers!

 

I go to sleep reasonably well but I wake up early and check the pre-market quote.  As Sanjeev knows, on the West coast that comes pretty darn early... at 4:30am which is a fact I didn't even realize until the past few months.

 

I just sleep with Bloomberg or CNBC on all night, so I sleep, but periodically wake up to see if anything is happening...just habit!  In the fall and winter months, I like falling asleep on the great room sofa with the warm glow of the fireplace late at night, and so many nights it's been joined by the neon glow of the television as well.  Cheers!

 

Gosh this makes me feel better! I though I was in the minority tracking everything real time, checking quotes in the middle of the night and not being able to sleep waiting for that "press release"! It's a sick obsession for sure.

[ERICOPOLY]

 

 

BAC cost of capital is higher than WFC because of the long term debt of country wide and Merrill...these will run off with time but more legacy high cost of capital is parpt of the hand "new Bac was handed"

 

The market is saying we want to see it happen...all of what we assume will improve at "New Bac" over time...lawsuits, cost of capital, regulatory issues, business plan etc...

 

And then Europe pops up....and then china pops up and the market sees another crisis...so stock drops are two fold:

 

1. Is the New Bac working?

2. A bankruptcy of the Pigs will cause a crisis.

 

The frustrating part is they have no control over Europe and the market is terrified by it.

 

We have traded the stock...bought options $10 options at $6 range sold them..

 

We have only held common stock since then and again traded  noting $10 has been a barrier the market is unwilling to pay for.

 

To us short term europe is the issue...we watch bond yields there closely...they are 90% correlated to the price of Bac stock....like it or not this is the case...any type of resolvement there is the key to Bac confidence.

 

We agree everyone is right in the long term..but in order for 1. To be recognized 2. Has to be stable...so getting the timing right is extremely tough. Return of capital will help but again that is down the road.

Dazel.

 

JPM has that same Euro headline but enjoys a much richer valuation.

 

So I think BAC can at least get to JPM's valuation in two ways:

1)  settle with GSEs on putbacks (this, after all, at most only costs an extra bilion beyond existing reserves)

2)  over next two years those expenses come out.  Having a strong balance sheet to protect against a shock is one thing, having an engine churning out a high current level of profits to replenish it is another.  It's certainly better to have both as JPM does right now already.  Having a machine gun in the trenches that's jammed is not as soothing as having one in full working order -- even if you are promised that the jam will be cleared, you're not certain it will happen before the shooting starts.

 

[redskin]

This is not my base case, but my Lollapalooza upside on BAC. 

 

1)BAC increases assets proportional to GDP growth over the next 6 years (Coincides with warrant expiration).  Let's say real GDP of 2% along with 3% inflation for annual growth of 5%.  Total assets increase from the current $2.16 trillion to $2.9 trillion. 

 

2) BAC return on assets is 1.35%

 

3) BAC is able to buy back $100 billion of stock over next 6 years at an average price of $35/share.  2.85 billion shares total.  Decreases share count from 10.5 to 7.65 billion.

 

4) BAC net income is 39.15 Billion (2,900B * .0135) on 7.65B shares.  EPS= 5.12

 

5) BAC is rewarded a multiple of 12X earnings. 

 

Share price= $61  36% annualized

 

One extra to your possible lollapalooza MrB: what if Moynihan has been under-promising New BAC?

 

I'm almost sure that there is a lot of fat in there. Bank of America was never very good integrating at their acquisitions. Not just Merrill and Countrywide, LaSalle was a mess too. They jumped too quickly from one acquisition to the next one, both Ken Lewis and Hugh McColl (Wasserstein, Big Deal good book). Thirty years, dozens of acquisitions.

 

There is no reason that Bank of America should not have the same profitability as Wells Fargo when both have the same cost of funds. And that is higher than the profitability we've been discussing.

 

 

Possible contributors to Lollapalooza Effect at BofA over the long run?

This is not to ignore the risks/downside. Let's assume for a moment it works out beyond our wildest expectations. If we look back in 10 years, what would we say we could have seen now that would have pointed to BofA possibly working out fantastically?

 

• Economic recovery, slowly but surely
  
• Fundamental shift in the business model of BofA. More like Wells Fargo
  
• O'Neal and his predecessor's dream of marrying BofA and Merrill's. Turns out to be a great idea.
  
• Countrywide's contribution once its fixed.
  
• Business wins from European banks as they still have to deleverage massively.
  
• Big banks come out stronger at the expense of smaller banks and end up with a bigger piece of the pie.
  
• Moynihan ends up being an astute capital allocator, even in the good times.
  
• General sentiment changes towards the banks leading to P/BV multiples of 2 and above again.
   
  

 

Agree, disagree? Care to add any?

[Guest Dazel]

 

Ericopoly,

 

I am not arguing with your or anyone else's logic...on the future...but do not give he crowd too much credit...they do not care about the future...what are you doing now.

 

Bac, c, Aig are all suffering for the two reasons I mentioned...but investors are willing to hold the other banks because of yield.

 

Jpm- 3% yield

WFC-2.72%

USB-2.42%

 

We have done very well trading GGP over the last 4 years...very simply under the assumption the world would sell on fear and buy on yield. We see nothing to stop this thesis.

 

Dazel.

[ERICOPOLY]

Dazel,

Your comment on the PIIGS fears and BAC price correllation resonated with me because that's what I've been seeing too.  However I figured people are afraid that in a crisis BAC's earnings power isn't up to snuff yet -- if this PIIGS fear were simply a derivates/domino issue then JPM is in the same boat.  Thus (because JPM is not quite as discounted) I reasoned it is because BAC's earnings power is being masked by these expenses.  And there is some element of risk in that -- I mean, JPM is probably stronger even with lower capital levels because the money is flooding in the front door.

 

I hadn't considered your point about dividend yield -- maybe that's true.  If so, then we'll see soon if the discount lifts a bit when BAC raises in March/April

 

Regarding that PIIGS related volatility again...

Back in March, George Soros pointed out that given the progress the Eurozone banks have made since 2010, the window for banking crisis (at that time) was two more years into the future.  After that two year period he thought a breakup of the Euro would be possible without a banking crisis.

 

So that gives us (based on his estimate), a bit more than one more year.  Thus (again by his estimate), that discount will be lifted by 2015.

 

Soros doesn't know everything but he has some good thoughts on these matters.

[goldfinger]

I am not arguing with your or anyone else's logic...on the future...but do not give he crowd too much credit...they do not care about the future...what are you doing now.

 

Excuse my naive and simplistic point of view: I thought that the focus on fundamentals and long-term outcomes is a big part of the value-investor edge against the crowd and against our inability to explain certain short-term behaviors or phenomena with certainty.

::)

[goldfinger]

However I figured people are afraid that in a crisis BAC's earnings power isn't up to snuff yet

 

I think this explains most probably the current trading patterns with BAC. It can change on a dime - for example if less legacy cost hits BAC.

 

Correlations can change very quickly, what matters the most is to understand where they come from if you consider them - which may be very hard to do especially in the short term.

[ERICOPOLY]

This is not my base case, but my Lollapalooza upside on BAC. 

 

1)BAC increases assets proportional to GDP growth over the next 6 years (Coincides with warrant expiration).  Let's say real GDP of 2% along with 3% inflation for annual growth of 5%.  Total assets increase from the current $2.16 trillion to $2.9 trillion. 

 

2) BAC return on assets is 1.35%

 

3) BAC is able to buy back $100 billion of stock over next 6 years at an average price of $35/share.  2.85 billion shares total.  Decreases share count from 10.5 to 7.65 billion.

 

4) BAC net income is 39.15 Billion (2,900B * .0135) on 7.65B shares.  EPS= 5.12

 

5) BAC is rewarded a multiple of 12X earnings. 

 

Share price= $61  36% annualized

 

One extra to your possible lollapalooza MrB: what if Moynihan has been under-promising New BAC?

 

I'm almost sure that there is a lot of fat in there. Bank of America was never very good integrating at their acquisitions. Not just Merrill and Countrywide, LaSalle was a mess too. They jumped too quickly from one acquisition to the next one, both Ken Lewis and Hugh McColl (Wasserstein, Big Deal good book). Thirty years, dozens of acquisitions.

 

There is no reason that Bank of America should not have the same profitability as Wells Fargo when both have the same cost of funds. And that is higher than the profitability we've been discussing.

 

 

Possible contributors to Lollapalooza Effect at BofA over the long run?

This is not to ignore the risks/downside. Let's assume for a moment it works out beyond our wildest expectations. If we look back in 10 years, what would we say we could have seen now that would have pointed to BofA possibly working out fantastically?

 

• Economic recovery, slowly but surely
  
• Fundamental shift in the business model of BofA. More like Wells Fargo
  
• O'Neal and his predecessor's dream of marrying BofA and Merrill's. Turns out to be a great idea.
  
• Countrywide's contribution once its fixed.
  
• Business wins from European banks as they still have to deleverage massively.
  
• Big banks come out stronger at the expense of smaller banks and end up with a bigger piece of the pie.
  
• Moynihan ends up being an astute capital allocator, even in the good times.
  
• General sentiment changes towards the banks leading to P/BV multiples of 2 and above again.
   
  

 

Agree, disagree? Care to add any?

 

Dang, another round of drinks for you!

[Guest Dazel]

 

Ericopoly,

 

To be sure I am sick of the Europe story...while I have played close attention to the yields and fluctuations...and followed Soros thoughts amongst others...I do not want cloud this great thread with my thoughts there other than the obvious correlation with BAC...

And I agree Goldfinger correlations change.

 

The release on capital to dividends or buy backs is a big part of the BAC comeback story...I agree...and I am not a fortune teller...BAC could take off on the right settlements...in love the company long term...and it very easily could take off...sentiment is changing. However, fact is that dividend stocks are not fluctuating like the other stocks...It seems that 2.5 to 3% is the yield range people will pay up for and 4% is the bottom for bargain hunters during sell offs.

 

Having said that...

 

Mr. Buffett once stated that his biggest advantage for years was the fact he had no memory of the 1929 crash and all of the fear that brought to investors.

 

I have contemplated this deeply....as we have seen a similar event... The fact is the Euro trades at $1.30...how worrisome is that?

 

Dazel.

[ERICOPOLY]

There is no reason that Bank of America should not have the same profitability as Wells Fargo when both have the same cost of funds. And that is higher than the profitability we've been discussing.

 

At the moment (WFC vs BAC):

 

The difference in funding cost is 48 bps

The difference in yield on total earning assets is 87 bps

 

Put it together and it's 135 bps

 

Total opportunity for BAC (in catching WFC):  .0135 X $1.75t = $23.62b

 

64% of the opportunity is to be had in the yield on total earning assets.  See page 26 of BAC 10-Q to see the breakdown of yield on those assets.  Also see page 7 of WFC 10-Q for their version of the same.

[Uccmal]

Dazel et al, These are posts from page 1 of this thread, two years ago:

 

Here are the problems I see with investing in BAC, warrants or common:

1) It is not really clear, and in fact, nearly incomprehensible, as to what may still be lurking on their balance sheet.

2) The stock could implode due to bad banking practices as in observation 1)

3) The bank could be forced into asset sales to bolster its balance sheet at some point in the future reducing its book value.

4) Regulation could wipe out profitability for years going forward. 

5) As per number 1 - BV could be vastly inflated due to toxic waste on the balance sheet.

[Uccmal]

Part two:

 

The flip side of the negative outlook is the following:

 

1) Most of what is dangerous on BACs balance sheet is probably well known and visible now. 

2) BAC was a go to bank for the US government when they needed someone to take Merril Lynch private

3) Their capital position appears strong at this point in time and their operating earnings appear to be improving. 

4) They are already taking write downs related to regulatory changes with regards to fee income. 

5) Regulation will have some short term effect on profitability but I am quite confident that the big banks will find ways to make money hitherto unknown.

6) Mortage securities - someone mentioned on the other thread that we are now fighting the last battle.  I tend to agree.  There is little chance of BAC losing 50B on a re-buy scenario. 

 

So looking at the stock and the warrants.  A return to book value, assumming some percentage of impairment brings the stock price today up to say $17.  Growth of 10% average in earnings over the next 9 years brings me to a price of $34.00.

[Uccmal]

Points from the above two posts:

 

Part 1:

1) We definitely know much more about their balance sheet

2) Stock not likely to implode due to banking practices

3) Asset sales are done

4) Regulation is having minimal effect on profitability so far

5) BV was not inflated two years ago and has risen

 

Part 2: the flip side:

1) still the same.  The balance sheet is much more visible

2) no comment

3) Capital position way stronger than two years ago

4) writedowns related to fee income are now a trickle

5) too big a topic to enumerate

6) This thesis is intact - MBS securities ar actually starting to be in demand and old ones are increasing invalue.  40 B in costs from Countrywide, and much of them are from before I made the post two years ago.

 

The stock is three to four dollars cheaper today than 2 years ago, and the warrants are 60%.  I would suggest we are sitting on the powder keg, getting ready to be blasted skywards, regardless of the macro environment. 

 

 

[PlanMaestro]

The difference in funding cost is 48 bps

 

The difference in cost of funds is just 4bps.

 

What we are talking about with the lollapalooza of catching up with Wells is the difference between a 1.3% ROA bank and a 1.6% ROA bank. That's a potential of $7 billion of extra profit, or around $0.6 of extra EPS.

 

http://farm9.staticflickr.com/8345/8178797953_a9a8e045cd.jpg

[ERICOPOLY]

The difference in funding cost is 48 bps

 

The difference in cost of funds is just 4bps.

 

What we are talking about with the lollapalooza of catching up with Wells is the difference between a 1.3% ROA bank and a 1.6% ROA bank. That's a potential of $7 billion of extra profit, or around $0.6 of extra EPS.

 

http://farm9.staticflickr.com/8345/8178797953_a9a8e045cd.jpg

 

Right off the bat, I'm going to guess that your chart is only looking at one funding source, that being deposits.

 

Something worth pointing out is this:

deposits fund 60% of BAC's average earning assets  (1.75t total earning assets)

deposits fund 76% of WFC's average earning assets  (1.17t total earning assets)

 

BAC's latest quarterly cost of funding those 1.75t of assets was $4.038 billion.

that's 92 bps of funding cost

see page 28 of BAC's 10-Q

 

Wells Fargo's latest quarterly cost of funding those 1.17t of assets was $1.266 billion

that's 43 bps of funding cost

see page 7 of WFC's 10-Q:  https://www.wellsfargo.com/downloads/pdf/invest_relations/3Q12_10Q.pdf

 

So the difference is 48 bps in funding cost.  Actually, my numbers say it's 49 but I think that's a glitch from using round numbers.

[kevin4u2]

The difference in funding cost is 48 bps

 

The difference in cost of funds is just 4bps.

 

What we are talking about with the lollapalooza of catching up with Wells is the difference between a 1.3% ROA bank and a 1.6% ROA bank. That's a potential of $7 billion of extra profit, or around $0.6 of extra EPS.

 

http://farm9.staticflickr.com/8345/8178797953_a9a8e045cd.jpg

 

Eric is right.  It is 48bps. Go to the financials and do the math. Not sure what this spreadsheet is comparing but it's different or for another quarter.

[ERICOPOLY]

Even if BAC were to keep the LT debt footprint the same, just getting down to WFC's cost of LT debt would save $2 billion a year pre-tax.

 

BAC pays 3.07% on it's LT debt and WFC pays 2.37%.

 

[PlanMaestro]

Eric, that table comes directly from the FDIC Call Reports numbers. If the regulated subs had debt, it would include it. And that cost of funds is the best assessment of franchise value for the retail bank side.

 

Another point to note is that retail deposits and liquidity are not fungible, there is a process of distributing resources to the parent, and from the parent to the subs. Deposits at the retail bank do not fund Merrill Lynch.

 

http://www.sec.gov/Archives/edgar/data/65100/000006510012000051/ml-9302012x10q.htm

 

Yes… they have kept reporting, one nice secret that is not secret any more.

 

It is possible to use holding numbers and do a bottom up analysis, but be careful to adjust for business mix (especially investment banking), risk weight, and possible double-counting. $23 billion (>$2 EPS)  just in interest margin opportunity is out of proportion with reality. That is why it's better to compare similar business to similar business.

 

 

 

Even if BAC were to keep the LT debt footprint the same, just getting down to WFC's cost of LT debt would save $2 billion a year pre-tax.

 

BAC pays 3.07% on it's LT debt and WFC pays 2.37%.

[ERICOPOLY]

Eric, that table comes directly from the FDIC Call Reports numbers. If the regulated subs had debt, it would include it. And that cost of funds is the best assessment of franchise value for the retail bank side.

 

Wherever that table comes from...

 

Does it reconcile with the 10-Q that comes directly from the horse's mouth?

 

The number in that table is wrong not just for BAC, but for WFC as well.  WFC's 10-Q states that their cost is 43 bps, but the table claims it's only 26 bps.

 

Go to page 7 of WFC's 10-Q and look for the line "total funding sources" -- then look over two colums and see the number '43'.

 

So either BAC and WFC are both making errors in the 10-Q, or the table is not accurate.

 

My money is on the table being wrong.

 

 

[PlanMaestro]

http://newsandinsight.thomsonreuters.com/Legal/News/2012/11_-_November/Banks_should_fear_ominous_new_rulings_in_Fannie/Freddie_MBS_cases/

 

And if that's not enough to scare the banks into settlement talks, consider Cote's findings in Thursday's decision upholding just about all of the FHFA's claims against Merrill Lynch. In particular, Cote refused to rule out the possibility of rescission -- which would require Merrill to buy back the FHFA's holdings in Merrill MBS offerings -- and punitive damages. Merrill argued that the FHFA waited too long to file claims to demand rescission under the Securities Act and the common law; Cote said there were plenty of legitimate reasons for the FHFA's delay in filing. As for punitive damages, which are based on New York law, Merrill asserted that the FHFA hadn't shown the requisite exceptional misconduct. Cote disagreed, in what has to be considered ominous language for the bank defendants.

 

"FHFA alleges that the defendants acted recklessly by seeking to profit from ever more risky mortgage lending while, at the same time, passing on the risk (and ultimately the losses) associated with these practices to the public via their sale of securities to Fannie Mae and Freddie Mac," Cote said. The judge went on to turn the banks' arguments that Fannie and Freddie's MBS losses were due to a downturn in the housing market completely against the banks. They're not the victims of the housing crisis, she wrote, but (at least according to FHFA) the cause of "the most severe economic downturn this country has experienced since the Great Depression." And yes, she said, "These allegations are sufficient to support the plaintiff's demand for punitive damages."

 

[PlanMaestro]

OK Eric, you must be right. Regulators are such idiots and Bank of America should earn in excess of $5 EPS including taxes. Or maybe you did not read the answer or do not know what a Call Report is.

 

https://cdr.ffiec.gov/public/

 

It is possible to use holding numbers and do a bottom up analysis, but be careful to adjust for business mix (especially investment banking), risk weight, and possible double-counting. $23 billion (>$2 EPS)  just in interest margin opportunity is out of proportion with reality. That is why it's better to compare similar business to similar business.

 

Wherever that table comes from...

 

Does it reconcile with the 10-Q that comes directly from the horse's mouth?

 

The number in that table is wrong not just for BAC, but for WFC as well.  WFC's 10-Q states that their cost is 43 bps, but the table claims it's only 26 bps.

 

Go to page 7 of WFC's 10-Q and look for the line "total funding sources" -- then look over two colums and see the number '43'.

 

So either BAC and WFC are both making errors in the 10-Q, or the table is not accurate.

 

My money is on the table being wrong.

[ERICOPOLY]

OK Eric, you must be right. Regulators are such idiots and Bank of America should earn in excess of $5 EPS including taxes. Or maybe you did not read the answer.

 

https://cdr.ffiec.gov/public/

 

Wherever that table comes from...

 

Does it reconcile with the 10-Q that comes directly from the horse's mouth?

 

The number in that table is wrong not just for BAC, but for WFC as well.  WFC's 10-Q states that their cost is 43 bps, but the table claims it's only 26 bps.

 

Go to page 7 of WFC's 10-Q and look for the line "total funding sources" -- then look over two colums and see the number '43'.

 

So either BAC and WFC are both making errors in the 10-Q, or the table is not accurate.

 

My money is on the table being wrong.

 

Your are taking the same tone you took with me in private mail yesterday.

 

"oh Eric, you must be right.  Regulators are such idiots".

 

Why is it that you don't just look in WFC's 10-Q and tell me what the number says for "total funding sources" and then check it against your table?

 

 

 

 

[Grenville]

http://newsandinsight.thomsonreuters.com/Legal/News/2012/11_-_November/Banks_should_fear_ominous_new_rulings_in_Fannie/Freddie_MBS_cases/

 

Thanks for the article.

[PlanMaestro]

Eric,

 

(1) Do you know what a call report is?

(2) Do you understand the difference between a call report and the 10Q?

(3) Why ad hominem instead of addressing the specific points?

(4) Do you understand the implications of your NIM "opportunity" in terms of ROA (reality check)?

 

 

PS: You must be confusing me. I never commented on the regulators in our messages.