BAC-WT - Bank of America Warrants

[ERICOPOLY]

I'm not 100% sure but I think you're essentially betting that BAC will become one of the top market cap companies in the world.  More than Microsoft, Walmart, GE, Berkshire, Google, etc.  A $300Bn market cap would put BAC at #3 in the world today, behind only Apple and Exxon.  Up there, I think P/E's compress, margins compress, simply because at that size it is difficult to grow.  Everyone starts gunning for ya, litigators, competitors, regulators, politicians...

 

This isn't to say it won't happen.  I will be pleased if it does, for both my sake and yours, it's just that I'm not convinced this is the likely outcome.  If that were the likely outcome, why doesn't Buffett stick a few billion more into BAC?  AFAIK he has not bought any on the open market.  (I know they held BAC in the past but that was Simpson, not Buffett).  He continues to buy IBM, WFC, etc. 

 

So the roughly $2/share in earnings also jives with their overview on normalized PTPP analysis. 

 

But my question for the board is, if BAC trades at a 10x multiple, that's a $20 share price, then why the interest in the warrants? 

 

We only need 2-3 more dollars with no adjustment for dividends/buybacks for it to work out better than common, and even at $20 you still do quite well, though not quite as good as common.  Also, that's assuming no growth up to 2019, so it shouldn't be too hard to get more than $2 EPS.  Also, isn't $2 on the low side if we are expecting more normal ROA/ROE (e.g., similar to WFC, which is trading well over book value)?  If we get to WFC valuations, that's $25+ per share without any change in current equity. 

 

Also, I think most of us have a basket of common/warrants with a leaning to common, so the warrants are for the big upside.

 

$2 a year average capital return.

6 years  x $2 = $12

$20+$12 = $32

$32 - $13.3 = $18.7

$18.7 / $3.80 = 4.92x

 

Thus, warrants are a 5 "bagger" (I hate that term btw) assuming a $2 a year average capital return and a no growth business spitting out $2 a year that's valued at 10x earnings or $20 stock price.

 

Common stock under that sceario is only a 3.55x return.

 

In short,

4.92x vs 3.55x

 

38.5% more money at the end of the period given those assumptions.

 

Is there that big of difference between $220 billion and $300billion?  Is $220 billion small and nimble but we draw the line at $300 billion?  $220 billion is where we're at for 10x earnings at 15% ROE in this interest rate environment, $300 billion is where we get to if they pick up another 70 cents per share of revenue from a more favorable interest environment.

 

I think when you pointed out that he keeps putting more money into IBM (at 211bn market cap) you are sort of weakening the notion that Buffett is turning down more BAC due to size.

 

He did say that he wanted to put twice as much into the BAC deal as what he was able to.  Of course, that doesn't stop him from adding common to it.

 

There are lots of small banks that he isn't buying -- instead he wants more WFC, which itself is a monster.

[ERICOPOLY]

GOOG and many of these other companies ought to be over $300 market cap anyhow by then -- this isn't for another 6 years after all.  GOOG might be over $400bn.

 

I still don't see how it's related though.

[hyten1]

eric no prob, i prob didn't word it correctly either

 

base on what you lay out (own A and possibly short B)

 

i am trying to get an idea of the following

 

comparing the following in the event of price going down or up

 

1. owning A only

2. owning A and short B (in the event B has reach a decent percentage of what you layout to buy A)

 

since if you short B in the event stock goes up you would be more out of the money with your short of B

 

trying to get an idea of the spread because at some point (lets say stock shots UP, way UP) option 1 would be more advantages than 2 since you have short B, if BAC goes up by a lot you would lose more money on your short that will each away at your A. but the advantage is you take your money off the table in the event stock goes down etc.

 

that is all

 

hy

 

so eric essentially due to the spread btw A and B (meaning since B expires early and has a higher price, it tend to move up slower and move down faster than A?)

 

you can take your money off table by shorting B at the same time still be able to take advantage of the up side?

 

how to you come to grip what your gains and losses will be if you do this? since i don't have a grasp of how much A or B will move up if BAC is at X price by Y date?

 

hy

 

 

I just wanted to point out that while these things might look very risky to some if held to maturity (due to perhaps a financial crisis or world war or whatever near maturity in 2019), they have an advantage in that they decay slowly and if we get some kind of a run to $20 when "the space station is fully operational" and they blast Dantooine" (pay a full dividend), there is a way that I outlined of getting most of your initial money out.  So you can dance and chew gum at the same time.

 

And you would tend to think that if the stock were trading at $20 right now, what would the $25 strike call trade for?  Once the discount in the stock is fully lifted and you still have years to warrant maturity, perhaps you write covered calls (given the leverage the covered call premium ought to be a fairly robust % of your initial outlay).

 

Anyhow, I haven't talked to my broker about how the margin works on the warrants.  Will shorting the B warrant eat into my margin capacity or will it be considered to be "covered" by the A warrant.

 

EDIT:  Apologies, I sort of didn't understand your questions fully so I repeated myself in different wording to see if that would work.

[hyten1]

eric i hear ya, the market cap is something i am always weary about

 

i guess i tend to want to stick to being more conservative, valuation is a tricky thing, definitely you can argue right now goog should have 400bn as long as people are willing to pay a higher multiply (which is not impossible)

 

i guess i would rather not bet on an environment were the market is willing to pay for a higher multiple (it has happen in the past no question, it could happen again no question)

 

 

 

GOOG and many of these other companies ought to be over $300 market cap anyhow by then -- this isn't for another 6 years after all.  GOOG might be over $400bn.

 

I still don't see how it's related though.

[hyten1]

eric i am curious

 

what is your low case vs reasonable vs optimistic case for BAC?

 

 

hy

 

GOOG and many of these other companies ought to be over $300 market cap anyhow by then -- this isn't for another 6 years after all.  GOOG might be over $400bn.

 

I still don't see how it's related though.

[xazp]

To me it's like asking, what's the difference between a 7' person and a 6' person, it's only 16%.  7' people exist, but they're much rarer than 6' people.  Company market caps are not evenly distributed, they're a fat tail, so most of them are small, some medium, and only a few large.  There are many more companies at $0-$100Bn market caps than $100-$200Bn, and those exceed the $200-$300Bn level, and it's very thin above $300Bn.  And frankly I do not think of BAC in the same league as the others that have achieved that level in history. 

 

What would really change things for me is if BAC can buy many shares below TBV and really drop the share count.  I find it much more plausible that BAC hits a $200Bn market cap on 7Bn shares and $20Bn of earnings.  But so far, BAC has only gone in the other direction - they've diluted their shareholder base.  They do not behave like a company who believes their shares are worth $20. 

 

 

Is there that big of difference between $220 billion and $300billion?  Is $220 billion small and nimble but we draw the line at $300 billion?  $220 billion is where we're at for 10x earnings at 15% ROE in this interest rate environment, $300 billion is where we get to if they pick up another 70 cents per share of revenue from a more favorable interest environment.

 

I think when you pointed out that he keeps putting more money into IBM (at 211bn market cap) you are sort of weakening the notion that Buffett is turning down more BAC due to size.

 

He did say that he wanted to put twice as much into the BAC deal as what he was able to.  Of course, that doesn't stop him from adding common to it.

 

There are lots of small banks that he isn't buying -- instead he wants more WFC, which itself is a monster.

[ERICOPOLY]

eric no prob, i prob didn't word it correctly either

 

base on what you lay out (own A and possibly short B)

 

i am trying to get an idea of the following

 

comparing the following in the event of price going down or up

 

1. owning A only

2. owning A and short B (in the event B has reach a decent percentage of what you layout to buy A)

 

since if you short B in the event stock goes up you would be more out of the money with your short of B

 

trying to get an idea of the spread because at some point (lets say stock shots UP, way UP) option 1 would be more advantages than 2 since you have short B, if BAC goes up by a lot you would lose more money on your short that will each away at your A. but the advantage is you take your money off the table in the event stock goes down etc.

 

that is all

 

hy

 

so eric essentially due to the spread btw A and B (meaning since B expires early and has a higher price, it tend to move up slower and move down faster than A?)

 

you can take your money off table by shorting B at the same time still be able to take advantage of the up side?

 

how to you come to grip what your gains and losses will be if you do this? since i don't have a grasp of how much A or B will move up if BAC is at X price by Y date?

 

hy

 

 

I just wanted to point out that while these things might look very risky to some if held to maturity (due to perhaps a financial crisis or world war or whatever near maturity in 2019), they have an advantage in that they decay slowly and if we get some kind of a run to $20 when "the space station is fully operational" and they blast Dantooine" (pay a full dividend), there is a way that I outlined of getting most of your initial money out.  So you can dance and chew gum at the same time.

 

And you would tend to think that if the stock were trading at $20 right now, what would the $25 strike call trade for?  Once the discount in the stock is fully lifted and you still have years to warrant maturity, perhaps you write covered calls (given the leverage the covered call premium ought to be a fairly robust % of your initial outlay).

 

Anyhow, I haven't talked to my broker about how the margin works on the warrants.  Will shorting the B warrant eat into my margin capacity or will it be considered to be "covered" by the A warrant.

 

EDIT:  Apologies, I sort of didn't understand your questions fully so I repeated myself in different wording to see if that would work.

 

 

That's right, if the stock shoots way up then shorting B may have seemed safer, but untimately not the most optimal.

 

I'm also not necessarily really going to do this.  It's just a strategy to consider.

 

It's like if somebody buys the $10 call option for $2 and argues that it's only a double if the stock closes at $14 on expiration.  Well, not if the person waited for the first significant rally and wrote a covered call with $14 strike for $2.  In that case, it would be a triple at expiration.

 

Options look really risky if you shoot for the moon, risk of losing everything, but if you think of buying them with very long term expirations and operate with the mindwet of retrieving a good portion of your options premium after a sizeable rally, then the risk profile is considerably different.

[ERICOPOLY]

To me it's like asking, what's the difference between a 7' person and a 6' person, it's only 16%.  7' people exist, but they're much rarer than 6' people.  Company market caps are not evenly distributed, they're a fat tail, so most of them are small, some medium, and only a few large.  There are many more companies at $0-$100Bn market caps than $100-$200Bn, and those exceed the $200-$300Bn level, and it's very thin above $300Bn.  And frankly I do not think of BAC in the same league as the others that have achieved that level in history. 

 

What would really change things for me is if BAC can buy many shares below TBV and really drop the share count.  I find it much more plausible that BAC hits a $200Bn market cap on 7Bn shares and $20Bn of earnings.  But so far, BAC has only gone in the other direction - they've diluted their shareholder base.  They do not behave like a company who believes their shares are worth $20. 

 

 

Is there that big of difference between $220 billion and $300billion?  Is $220 billion small and nimble but we draw the line at $300 billion?  $220 billion is where we're at for 10x earnings at 15% ROE in this interest rate environment, $300 billion is where we get to if they pick up another 70 cents per share of revenue from a more favorable interest environment.

 

I think when you pointed out that he keeps putting more money into IBM (at 211bn market cap) you are sort of weakening the notion that Buffett is turning down more BAC due to size.

 

He did say that he wanted to put twice as much into the BAC deal as what he was able to.  Of course, that doesn't stop him from adding common to it.

 

There are lots of small banks that he isn't buying -- instead he wants more WFC, which itself is a monster.

 

Except in this case they are already a 7' person.  Look at the size of the balance sheet.  All we're talking about is getting a 10x multiple after cutting expenses.  Then, we're still in a depressed interest rate environment and we're just expecting a normal interest rate environment 6 years from now.

 

We've got a 7' person that has poor posture and only looks to be 6'.

 

I'm saying if he just stands up straight he'll be 7' and you are arguing that it's rare to be a 7' person.

 

[Investmentacct]

Why are the analysts consistently ignoring what Moynihan says and just making up stuff out of thin air?

 

Only reason I could think of is most of them got burnt by BAC 4 short years earlier. So they behave like Mark Twain's cat: "A cat who sits on a hot stove will never sit on a hot stove again. But he won’t sit on a cold stove, either."

[redskin]

A bank that holds over 10% of the deposits of the richest country in the world should be one of the most profitable and also become one of the largest measured by market cap.  I don't think that is a stretch.

 

I'm not 100% sure but I think you're essentially betting that BAC will become one of the top market cap companies in the world.  More than Microsoft, Walmart, GE, Berkshire, Google, etc.  A $300Bn market cap would put BAC at #3 in the world today, behind only Apple and Exxon.  Up there, I think P/E's compress, margins compress, simply because at that size it is difficult to grow.  Everyone starts gunning for ya, litigators, competitors, regulators, politicians...

 

This isn't to say it won't happen.  I will be pleased if it does, for both my sake and yours, it's just that I'm not convinced this is the likely outcome.  If that were the likely outcome, why doesn't Buffett stick a few billion more into BAC?  AFAIK he has not bought any on the open market.  (I know they held BAC in the past but that was Simpson, not Buffett).  He continues to buy IBM, WFC, etc. 

 

So the roughly $2/share in earnings also jives with their overview on normalized PTPP analysis. 

 

But my question for the board is, if BAC trades at a 10x multiple, that's a $20 share price, then why the interest in the warrants? 

 

We only need 2-3 more dollars with no adjustment for dividends/buybacks for it to work out better than common, and even at $20 you still do quite well, though not quite as good as common.  Also, that's assuming no growth up to 2019, so it shouldn't be too hard to get more than $2 EPS.  Also, isn't $2 on the low side if we are expecting more normal ROA/ROE (e.g., similar to WFC, which is trading well over book value)?  If we get to WFC valuations, that's $25+ per share without any change in current equity. 

 

Also, I think most of us have a basket of common/warrants with a leaning to common, so the warrants are for the big upside.

 

$2 a year average capital return.

6 years  x $2 = $12

$20+$12 = $32

$32 - $13.3 = $18.7

$18.7 / $3.80 = 4.92x

 

Thus, warrants are a 5 "bagger" (I hate that term btw) assuming a $2 a year average capital return and a no growth business spitting out $2 a year that's valued at 10x earnings or $20 stock price.

 

Common stock under that sceario is only a 3.55x return.

 

In short,

4.92x vs 3.55x

 

38.5% more money at the end of the period given those assumptions.

[ERICOPOLY]

eric i am curious

 

what is your low case vs reasonable vs optimistic case for BAC?

 

 

hy

 

GOOG and many of these other companies ought to be over $300 market cap anyhow by then -- this isn't for another 6 years after all.  GOOG might be over $400bn.

 

I still don't see how it's related though.

 

 

My reasonable case was the $200 bn market cap one.  5 bagger on the warrants.

My optimistic case was the $300 bn market cap one.  7 bagger on the warrants.

 

My pessimistic case would be putting a 5x multiple on earning at the terminal value due to a market crash, and assigning only $1.50 (relative to current share count) of average capital return each year.  That only gets me a 1.5x return on the warrants.

 

 

 

 

[bmichaud]

I don't understand the market cap argument at all. What company over $300B is trading at 5 times sustainable earnings as a penalty for low growth? If Apple can trade at ten times very fluffy earnings at a $500B or so market cap, I don't see any reason why BAC can't trade at 10 or even 12 times $30B of normal earnings.

 

Going a step further.....I don't see why Facebook, a company that contributes virtually nothing to society and generates less than $2B of earnings, can trade at a $50B market cap and BAC, with a rock solid long term business, and $20 to $30 billion of long run sustainable earnings power, can't trade in the upper echelon of corporate America valuation levels at a modest 10 to 12 PE.

[ERICOPOLY]

I don't see any reason why BAC can't trade at 10 or even 12 times $30B of normal earnings.

 

I always toss out the 10x earnings number, but I don't get why people wouldn't pay 12x.

 

Lower risk trading book and less leverage than in the past.  Risk adjusted, market premium should be higher than in the past.

[ERICOPOLY]

But so far, BAC has only gone in the other direction - they've diluted their shareholder base.  They do not behave like a company who believes their shares are worth $20. 

 

I didn't like the dilution either, but it doesn't mean they don't think they're worth $20.

 

It means they don't think they're worth $30, or $20, or $16, or $15, or $12 for that matter.

 

 

Or it says nothing about what they think they're worth.

[ERICOPOLY]

And actually the reason why it would be worth $300 billion is because we're talking about the merger of Merrill Lynch and Bank of America.

 

Just looking at Bank of America, it's deposit base and lending book is barely larger than Wells Fargo's.

 

So that makes Wells Fargo a 7' beast as well on apples to apples basis.  Why is Warren Buffett plowing money into a 7'er?

 

 

[Kraven]

 

But so far, BAC has only gone in the other direction - they've diluted their shareholder base.  They do not behave like a company who believes their shares are worth $20. 

 

They diluted because they had to.  Hindsight being 20/20 perhaps we can all argue they diluted too much, but tough to judge them doing things in the heat of the moment.  I am not sure they believed anything at all other than that they need to survive in order to later thrive.

 

We can all argue about how much the stock will be at whatever point in time people want to discuss.  Obviously we'll know when we know.  They clearly are heading in the right direction and so long as there isn't another financial crisis there is no reason they (and just about every other bank not horribly managed) won't get there.  Where's there?  Banks on average trade for around 70% or so of the market p/e historically.  A larger bank like a BAC with more visibility will trade for a higher multiple in good times. 

 

I view $2 a share almost as an index for what BAC can do.  It won't be exact, but it's probably pretty close.  Add in some buybacks, etc and who knows.  We don't know what the market multiple will be either, but we know the market is very fickle.  Already BAC has moved out of the penalty box and at least is sitting on the bench in terms of the public's eye.  At least they're no more or less hated than any other bank.  So they start paying a nice dividend, get the yield pigs back and I suspect that whatever happens with the stock price it won't be gradual.  For those that don't look at prices all the time I expect it will be the kind of stock where one day someone looks and says "damn, BAC is $18?  Last time I looked it was $9."  Or, to paraphrase Judy Blume, then again, maybe it won't.

[ERICOPOLY]

For those that don't look at prices all the time I expect it will be the kind of stock where one day someone looks and says "damn, BAC is $18?  Last time I looked it was $9."  Or, to paraphrase Judy Blume, then again, maybe it won't.

 

And in the pessimistic case where the stock doesn't climb in response to boosted capital return, it doubles the value of that returned capital if the stock remains mired at $10.  So bring it on.

 

The pessimist's viewpoint on stock recovery/valuation is not exactly too upsetting to me.  Although I'd rather just have the stock open at $20 tomorrow to be perfectly honest.

 

 

[Kraven]

For those that don't look at prices all the time I expect it will be the kind of stock where one day someone looks and says "damn, BAC is $18?  Last time I looked it was $9."  Or, to paraphrase Judy Blume, then again, maybe it won't.

 

And in the pessimistic case where the stock doesn't climb in response to boosted capital return, it doubles the value of that returned capital if the stock remains mired at $10.  So bring it on.

 

The pessimist's viewpoint on stock recovery/valuation is not exactly too upsetting to me.  Although I'd rather just have the stock open at $20 tomorrow to be perfectly honest.

 

I have a hard time seeing how they execute and aren't rewarded with at least a traditional bank p/e.  So assuming a market multiple of around 15, banks should be around 11 or so.  At $2 a share, that's $22 on the stock.  Once there is "visibility" (as if there really ever is), it's hard for me to see them lower than an 8 multiple.  I actually have much more confidence in the earnings power than the multiple.  As of right now, assuming nothing changes I have them at a fairly conservative $1.70 or so in earning power.  That assumes no buybacks, no improvement in the business other than to return to somewhat average performance.  So we'll see.

[jay21]

One thing that I am interested in is the interest rate risk of BAC (and all banks).  What if you have a large shift in interest rates?  Deposit funding becomes much more expensive and you have a lot of long term loans on your books.  Couldn't that severely hamper earnings power?

[Parsad]

I don't understand the market cap argument at all. What company over $300B is trading at 5 times sustainable earnings as a penalty for low growth? If Apple can trade at ten times very fluffy earnings at a $500B or so market cap, I don't see any reason why BAC can't trade at 10 or even 12 times $30B of normal earnings.

 

Going a step further.....I don't see why Facebook, a company that contributes virtually nothing to society and generates less than $2B of earnings, can trade at a $50B market cap and BAC, with a rock solid long term business, and $20 to $30 billion of long run sustainable earnings power, can't trade in the upper echelon of corporate America valuation levels at a modest 10 to 12 PE.

 

Don't get carried away guys.  We know that based on everything happening at BAC, even if the U.S. and global markets fell into a recession, that BAC should be able to earn $18-20B net profit in 2014...1% on assets...very conservative.  That's with a number of loan and legacy issues settled, capital ratios at least 50 basis points above Basel III, and much of their expense cutting and loan servicing completed. 

 

Two ways to value it simply and conservatively at that point: 

 

- Using 11B shares outstanding and assuming no buybacks, you get $1.64-1.83 in earnings per share with all the bad things in the past.  Give it a simple 10 times multiple for a good bank, with reduced risk and better capital ratios than most of their peers and you get $16.40 to $18.30 as the worst case scenario...unless the world blows up...I think 12 times is more reasonable, but I'm assuming banks are priced the same way as they are today!  The A warrants would trade between around $6-8...with four years left on them.  So your return would be anywhere between 75% to 110% depending on where you bought your equity and warrants.  Pretty damn good over 2 years, with very little downside risk.

 

- Using book value, at a bare minimum a decent bank with good ratios and operating profits should trade at 1.5 times tangible equity.  That gives you a price of $19.50.  And that's very conservative considering their liquidity, remaining legacy issues, cash flows, capital ratios, expense reduction and the mortgage industry in the U.S. today. 

 

I think it will overshoot both of those estimates, but that is what the worst case scenario in my mind (again, assuming the world doesn't spiral downwards into another depression) is for BAC within two years.  I suspect as the world muddles its way through the requisite deleveraging, you will probably see BAC trade at 1.25 times book...that may happen quicker than the above estimates, but I'm giving you a relatively pessimistic view of things.  Cheers!

[Parsad]

One thing that I am interested in is the interest rate risk of BAC (and all banks).  What if you have a large shift in interest rates?  Deposit funding becomes much more expensive and you have a lot of long term loans on your books.  Couldn't that severely hamper earnings power?

 

Yes, in the short-term.  But like insurance, you are constantly running off older business and writing new business at the higher rates.  So, it is a wash in the long-term as long as you stick to the basics and write good business, don't become overleveraged, and avoid stupid, greedy blowups.  Cheers!

[bmichaud]

The more I think about it, the more erroneous the mkt cap discussion is. Say BAC comes out Monday and says it grossly overestimated the time it will take to cut its expense base, and this weekend it cut $17B of expenses via a combination of layoffs, settlements and a sale of delinquent loans. So Monday morning the market would immediately reset BAC's share price according to the new earning power to say $18 per share. BAC trades about 200mm shares on high volume days, or just under 2% of fully diluted shares....so say in the first 10 minutes Monday morning BAC trades its typical volume (I.e. 200mm shares) and the new share price is $18...that's $3.6B of traded value ($18 pps x 200mm shares). So over night BAC's mkt cap goes from 100B to 200B with a mere $3.6B of actual call it "new capital" (I don't know what to call it...).

 

I'm rambling, but I guess what I'm trying to say is that a company's market cap is merely price times shares out, and it's not like $300B of new capital needs to come flooding in in order to drive up BAC's mkt cap. It's merely the market's perception of the underlying earning power that determines the share price. It's our job to determine the sustainability of those earnings.....so RIMM's giant mkt cap in 2007 was based on a wildly false perception of RIMM's core underlying earning power, yet the market still bid up the paper value of the company to absurd heights.

 

Again, sorry to ramble - clumsily trying to say that the mkt cap is merely coincidental to the legitimacy of the underlying earning power, and a no-growth PE should be at a minimum 8x if not 10x, if the market adheres to traditional cost of equity practices.

[Parsad]

The more I think about it, the more erroneous the mkt cap discussion is. Say BAC comes out Monday and says it grossly overestimated the time it will take to cut its expense base, and this weekend it cut $17B of expenses via a combination of layoffs, settlements and a sale of delinquent loans. So Monday morning the market would immediately reset BAC's share price according to the new earning power to say $18 per share. BAC trades about 200mm shares on high volume days, or just under 2% of fully diluted shares....so say in the first 10 minutes Monday morning BAC trades its typical volume (I.e. 200mm shares) and the new share price is $18...that's $3.6B of traded value ($18 pps x 200mm shares). So over night BAC's mkt cap goes from 100B to 200B with a mere $3.6B of actual call it "new capital" (I don't know what to call it...).

 

I'm rambling, but I guess what I'm trying to say is that a company's market cap is merely price times shares out, and it's not like $300B of new capital needs to come flooding in in order to drive up BAC's mkt cap. It's merely the market's perception of the underlying earning power that determines the share price. It's our job to determine the sustainability of those earnings.....so RIMM's giant mkt cap in 2007 was based on a wildly false perception of RIMM's core underlying earning power, yet the market still bid up the paper value of the company to absurd heights.

 

Again, sorry to ramble - clumsily trying to say that the mkt cap is merely coincidental to the legitimacy of the underlying earning power, and a no-growth PE should be at a minimum 8x if not 10x, if the market adheres to traditional cost of equity practices.

 

You are correct.  And remember, a well-run bank will always have a better moat and greater longevity than most technology companies.  Apple has to constantly reinvent itself and create a better product. 

 

In banking, the deposit base is relatively captive, as most people hate to switch banks, checking accounts, credit cards, etc.  As long as a bank can provide basic savings, lending, business services and investments, with the innate leverage they have, they can return 12-15% ROE for decades, while returning the bulk of that capital back in dividends, share buybacks or expanding their business.  Banking is simple, executives complicate it with their grandiose ideas.  And BAC as you know has the best deposit base in the world. 

 

As long as they keep it simple, and Moynihan sure is walking the talk, BAC will prove to be a good investment for many years.  I don't know what will happen after Moynihan, but as long as he is there, I think the culture has completely shifted and he won't forget these lean years.  Cheers!

[jay21]

One thing that I am interested in is the interest rate risk of BAC (and all banks).  What if you have a large shift in interest rates?  Deposit funding becomes much more expensive and you have a lot of long term loans on your books.  Couldn't that severely hamper earnings power?

 

Yes, in the short-term.  But like insurance, you are constantly running off older business and writing new business at the higher rates.  So, it is a wash in the long-term as long as you stick to the basics and write good business, don't become overleveraged, and avoid stupid, greedy blowups.  Cheers!

 

I agree, but I think that a shock in rates (e.g. the 10 year goes to 5%) could be very problematic and potentially catastrophic to certain banks.  When people are allowing for a more favorable interest rate environment in their analysis of the intermediate term, I am not sure how the bank can get there.

 

Also, in terms of run-off, I think that people need to remember there is an embedded option in a lot of loans.  If rates go up, it is more likely you will retain your low rate loans.

 

If anyone has any experience working at banks, I'd love to hear how the manage interest rate risk and if they know what banks are better or worse at it.

[Kraven]

One thing that I am interested in is the interest rate risk of BAC (and all banks).  What if you have a large shift in interest rates?  Deposit funding becomes much more expensive and you have a lot of long term loans on your books.  Couldn't that severely hamper earnings power?

 

Yes, in the short-term.  But like insurance, you are constantly running off older business and writing new business at the higher rates.  So, it is a wash in the long-term as long as you stick to the basics and write good business, don't become overleveraged, and avoid stupid, greedy blowups.  Cheers!

 

BAC is asset sensitive.  Everything being equal (and it never is), rising interest rates will help them, not hurt them.