BAC-WT - Bank of America Warrants

[txlaw]

Kraven, were you a banker or transactional lawyer when you were still working?

[Kraven]

Kraven, were you a banker or transactional lawyer when you were still working?

 

In a prior life I was a transactional lawyer.  I was a deal guy and spent a lot of time with bankers of various stripes.

[racemize]

Kraven, were you a banker or transactional lawyer when you were still working?

 

In a prior life I was a transactional lawyer.  I spent a lot of time with bankers of various stripes.

 

thank you for posting your insight on this stuff.

[txlaw]

Kraven, were you a banker or transactional lawyer when you were still working?

 

In a prior life I was a transactional lawyer.  I was a deal guy and spent a lot of time with bankers of various stripes.

 

Figured based on your posts.  (That's a compliment.)

[racemize]

comments re the likelihood of MBIA settlement.  Mostly a summary, but better than usual from thestreet

 

http://www.thestreet.com/story/11779144/1/mbiabank-of-america-settlement-odds-increase-analysts.html?puc=yahoo&cm_ven=YAHOO

[onyx1]

 

So a couple more points.  You are confusing R&W with covenants.  It's a very common misunderstanding.  A R&W is a statement as of a specific point in time.  The contract will be clear what point in time that is.  Usually it will be the date of the agreement, but can be as of an earlier date.  A covenant on the other hand is a promise if you will to do something on an ongoing basis.

 

Using your example of a 70% LTV, a rep says "As of the date of this agreement all loans have an LTV of 70% or less."  A covenant, on the other hand, says "All loans shall have an LTV of 70% or less until this Agreement terminates or, with respect to each loan, such loan has a principal balance of 25% or less of its principal balance on the date hereof, whichever is earlier."  In the first example, it's on/off.  Did all loans have an LTV of less than 70% on the date of the agreement (and that date only)?  The second example says was there any time from the date of the agreement until whenever that any loan exceeded a 70% LTV.  So what happens in the future in a rep means nothing.

 

Sorry, in the second example I didn't make it clear re-appraisal determined that the rep date LTV was closer to 75% than the contractual 70%.  Regardless, I understand your point about reps reflecting a snapshot in time. 

 

If what happens to after a rep is offered and accepted is irrelevant, then there isn't much to negotiate and BAC is a loser in this case.  But BAC clearly disagrees, and this raises the obvious question:  Why a settlement with Assured?  I don't know what AGO left on the table (if anything) but it seems to have embolden BAC into thinking they can get a similar agreement with MBI and other monolines. 

[Kraven]

 

So a couple more points.  You are confusing R&W with covenants.  It's a very common misunderstanding.  A R&W is a statement as of a specific point in time.  The contract will be clear what point in time that is.  Usually it will be the date of the agreement, but can be as of an earlier date.  A covenant on the other hand is a promise if you will to do something on an ongoing basis.

 

Using your example of a 70% LTV, a rep says "As of the date of this agreement all loans have an LTV of 70% or less."  A covenant, on the other hand, says "All loans shall have an LTV of 70% or less until this Agreement terminates or, with respect to each loan, such loan has a principal balance of 25% or less of its principal balance on the date hereof, whichever is earlier."  In the first example, it's on/off.  Did all loans have an LTV of less than 70% on the date of the agreement (and that date only)?  The second example says was there any time from the date of the agreement until whenever that any loan exceeded a 70% LTV.  So what happens in the future in a rep means nothing.

 

Sorry, in the second example I didn't make it clear re-appraisal determined that the rep date LTV was closer to 75% than the contractual 70%.  Regardless, I understand your point about reps reflecting a snapshot in time. 

 

If what happens to after a rep is offered and accepted is irrelevant, then there isn't much to negotiate and BAC is a loser in this case.  But BAC clearly disagrees, and this raises the obvious question:  Why a settlement with Assured?  I don't know what AGO left on the table (if anything) but it seems to have embolden BAC into thinking they can get a similar agreement with MBI and other monolines.

 

The first part is tough.  If a re-appraisal down the line determined that the rep was breached at the time (and not later), it is breached.  Knowledge of that doesn't matter (or shouldn't anyway).  But as with anything, how it would play out in court might not be so black and white.

 

In terms of whether BAC is the loser or not, again, it's not so easy.  Take the easiest example.  One loan, one breach.  That's easy.  That's not to say BAC doesn't still disagree and it needs to be litigated, but the issues are clear.  This is hundreds of thousands of loans and various different breaches for perhaps a majority (all?) of the loans.  I think this is the biggest issue.  How do the damages on that get determined?  As we've discussed, it's impossible to review each loan.  So MBIA has had a representative sample reviewed and wants to apply that to the pools as a whole.  The court has generally agreed this is acceptable.  BAC is arguing that.  I mean should they owe on say 500,000 loans (whatever the number is) when only a few hundred or thousand have been reviewed?  It's a fine line between requiring the impossible (i.e. reviewing all loans) and requiring BAC to be responsible for the whole on that basis.  So that's a real issue.

 

A lot of the other stuff like MBIA's reliance, their own "bad" acts, their knowledge (or lack thereof), that all seems like noise to me.  Always hard to know though what will happen.  I think if you could have a frank conversation with both parties, BAC would not deny they owe on the loans, but don't want to pay for it all since it's impossible to know the "true" damages and besides MBIA doesn't have the cleanest hands either.  I think MBIA would say we know we're not going to get everything we want, but need enough to commute the CMBS and pay back the loan to National with maybe a few bucks more.  In that, they will find compromise some day, some how.

 

In terms of Assured, I can't speak to that.  I don't know.  Different parties think different things.  Many companies hate litigation and would rather give something up then waste human capital stuck in court for years.  Thankfully that isn't a problem for MBIA as they are essentially (right now) a shell with 2 businesses - run off of old policies and litigation.  Other companies in their shoes would say let's just get enough and get back to business and being productive.  Clearly, they don't feel that way. 

[jay21]

Thanks for the insight on the reps and warranties, guys.

 

I want to recap the thesis for this stock, as I am thinking about allocating more capital here.

 

Thesis: Underlying profitability of the company is not being reflected in net income and the stock price.

 

Support:

  -Huge deposit base allows for low cost of funds

  - Stock is trading at a low multiple of PTPP (has mgmt ever given their estimates?  I thought I saw Plan say he gets 40b, anyone getting something very        different?)

  - Cost cuts and roll off of expensive funding further help the banks profitability

 

Bear Arguments

  - Litigation uncertainty

  - Poorly managed

  - Tepid loan growth and interest rate environment

  - Susceptible to an economic downturn

 

Did I miss anything important? 

 

 

[warrior]

I would add under the risk

Management cognitive an emotional biases.

 

 

[PlanMaestro]

Bank of America Backs Down On New Fees. http://online.wsj.com/article/SB10001424127887324020804578151410110949172.html

[Uccmal]

Thanks for the awesome summaries Kraven.  This type of shared skills is what makes this board so excellent. 

 

What I get from reading all of that is a couple of key thoughts:

1) Neither party is in any way innocent.  Mbia did not review the mortgages they insured, apparently not even a sampling.  Neither did BAC. 

 

Taking car insurance as an example that works reasonably well: I go in to get insurance on my car, am asked about my record by an agent, my age etc.  They pull my record, look at it, run the statistics on my demographic, and charge me according to all of this.

 

These mortgages were not being reviewed from the lender, and then subsequently not reviewed by the insurer.  Everyone was flying blind.  What a way to run a business.

 

Jay21,

 

I am using after tax near term earnings of $2/share - 20 Billion

BV is arounf 20$. TBV about 14$. 

 

A price estimate of 20$ at some point within a year, or year and a half does not seem outlandish.  I think we see a big jump the day the dividend is announced, as it puts the stock into the hands of alot more of the big conservative funds.  I hate using this term but there is a resistance level at 10$.  Once past the ten mark for a month or so, and I will bet that alot more funds buy in as well. 

 

The risk factors you have mentioned are probably priced in right now. 

 

Aside from some bonehead move by management that we cant predict, of course.

 

[Kraven]

Thanks for the awesome summaries Kraven.  This type of shared skills is what makes this board so excellent. 

 

What I get from reading all of that is a couple of key thoughts:

1) Neither party is in any way innocent.  Mbia did not review the mortgages they insured, apparently not even a sampling.  Neither did BAC. 

 

Taking car insurance as an example that works reasonably well: I go in to get insurance on my car, am asked about my record by an agent, my age etc.  They pull my record, look at it, run the statistics on my demographic, and charge me according to all of this.

 

These mortgages were not being reviewed from the lender, and then subsequently not reviewed by the insurer.  Everyone was flying blind.  What a way to run a business.

 

 

Sure, you're welcome.  It's an interesting topic.

 

Neither party was innocent.  No one who was a principal in those days was.  But innocence or lack thereof is a red herring.  It doesn't matter and distracts from the real issues.  It makes people emotional.  We all feel it, it's natural.  But a reps and warranties case isn't a determination of blame.  It isn't a cause and effect discussion.  Someone (the maker of the rep) has stated something is true and correct.  If it wasn't at the time the rep was made, the rep was breached.  That's it.  It doesn't matter whether the other party "knew" or not (although query whether one should have gone forward with a "bad" deal, but that's a separate issue). 

 

So it's not an attempt to figure out who did what.  It's an issue of facts and circumstances.  However, one point I raised is that a court always has 2 options in a commercial matter.  They can rule by following the law, or they can rule in the equities.  All that means is that they essentially aren't following the law but that the facts of this particular case are so extreme or bad that it would be a miscarraige of justice to rule in any other way.  Of course, that sets one up for appeal, etc. 

 

So just raising the example I gave before, there were old leasing cases where the doctrine of unconscionability came from.  I don't recall the details, but making something up, say the company is leasing to mainly an uneducated and largely poor and minority class.  These were the lease to own type things.  So say the contract says that the payment must be paid in cash, in a purple envelope at exactly 4:53 pm only on Fridays that are an odd date in the calendar.  If a payment is not made in that manner the contract is breached and the company can take back the merchandise and the person loses everything they've paid.  Of course the person can't even read and understand the contract.  This kind of thing happened for years.  The contract is clear and courts upheld them until a time when it was determined that no matter what the law this kind of contact simply can't be enforced as it is unequitable.

 

So a court here could say that since both parties are full of blame they can't enforce the contract, but that kind of thing normally doesn't happen with sophisticated parties.  I would be shocked to see that happen here.  So all the other stuff is noise.  I see it as a matter of trying to actually figure out what the breach is and what the corresponding damages are.  We know that SOME reps were breached for some loans.  Tough to know exactly how much.  I have a hard time seeing a court say that they should just put back the entire pool.  I still think the parties will grow up and settle this and that the settlement will likely favor MBIA.  They just seem to have far more leverage than BAC at this point.  Just my view.

 

I think too as to whether the mortgages were reviewed.  They probably were to the extent you could call what they did a review.  Someone looked at something.  It would have been impossible for MBIA to review the individual mortgages.  That's what the reps are for.  All they would have reviewed is pool level data.  There is no doubt in my mind they did do that.  So by that I mean Countrywide or whoever would simply provide them data on the pool as a whole.  LTVs are below X%, etc.  That's all MBIA would have been expected to do.  They may or may not have known that the data used to prepare the pool level data was suspect, but that's the purpose of getting the reps.  I doubt they would have gone forward if they truly thought the data was misleading or false.  Believe it or not, they were tough negotiaters back in the day.  They drove hard bargains.  Things changed when they were cranking out dozens of deals at a time. 

[jay21]

 

Jay21,

 

I am using after tax near term earnings of $2/share - 20 Billion

BV is arounf 20$. TBV about 14$. 

 

A price estimate of 20$ at some point within a year, or year and a half does not seem outlandish.  I think we see a big jump the day the dividend is announced, as it puts the stock into the hands of alot more of the big conservative funds.  I hate using this term but there is a resistance level at 10$.  Once past the ten mark for a month or so, and I will bet that alot more funds buy in as well. 

 

The risk factors you have mentioned are probably priced in right now. 

 

Aside from some bonehead move by management that we cant predict, of course.

 

Agreed.  I can't see a reason why the bank cannot earn $20b a year, which isn't even high profitability.  It wouldn't surprise me to see earnings over $25b in the near future.  Does anyone have insight about their capital plan? 

 

As far as the risk factors I listed, I think most of those are immaterial and management has proven themselves over the last year or two.  Therefore, I see this as a pretty riskless 50cent dollar.

[ERICOPOLY]

Does anyone have insight about their capital plan? 

 

Their B3 number was already at 9% at the end of Q3 and Moynihan doesn't plan on letting that number creep any higher.  This is the estimated 8.5% that they are required by regulators to maintain (in 2019), and on top of that a 50 bps buffer for things like legal settlements.  That comes straight out of Moynihan's mouth less than a month ago.  So it's pretty solid evidence of what they plan to do, even though the analysts seemingly choose to believe something entirely different. 

 

In other words, any time it exceeds 9% it's either time to make more loans or return the capital to investors via dividend or buyback.

 

The good news is that in the next 4 months we'll finally find out how much they plan on returning in 2013 -- thus analysts will be forced to pay attention to Moynihan finally.

[mankap]

I agree, that there is lot of skepticism among the analysts on the earning power and dividend payment of BAC.

Value line projects 0.24 as dividend and 0.90 as earning in 2015.

I think this is what is priced in the BAC share price.Once the street gets convinced that the dividend can be more than 0.24 in 2015 , share price will go up.

[ERICOPOLY]

I agree, that there is lot of skepticism among the analysts on the earning power and dividend payment of BAC.

Value line projects 0.24 as dividend and 0.90 as earning in 2015.

I think this is what is priced in the BAC share price.Once the street gets convinced that the dividend can be more than 0.24 in 2015 , share price will go up.

 

90 cents in 2015 is what I'm talking about -- Moynihan will tell the analysts that by 2015 the company will begin earning 13% to 15% on tangible equity which is at least $1.80 per share.

 

So they turn around and make up this 90 cent number.

 

 

[redskin]

I'm hoping for a $5 billion dividend and announcement of $10 billion share buyback.

[ERICOPOLY]

That is about my expectation too.  5+10.

[jay21]

Wouldn't that be excessive, about ~75% payout?  Anyone know off hand what the better banks (JPM, WFC) were approved for last year?

 

Also, valueline predicts 90c for next year.  1.35 in 2015.  If management cannot make 1% RoA and 10% RoE with that deposit base by 2015, I would think they get fired. 

[Guest rimm_never_sleeps]

i recall oakmark is looking for a dividend of around .45 annual exiting 2013. i believe big shareholders will be more than satisfied with a conservatively financed, 13% roe.

[Shane]

Eric - Just curious.  Do you plan on holding much of your BAC position after it hits ~$20 or whatever your price target is?  Maybe as a source of income?

 

Apologies if you have been asked this before - 200+ page thread..

[Kraven]

Also, valueline predicts 90c for next year.  1.35 in 2015.  If management cannot make 1% RoA and 10% RoE with that deposit base by 2015, I would think they get fired.

 

It's going to be a function, in part, of where interest rates are.  NIMs are getting squeezed now and that's not anyone's fault.  If we are still in a ZIRP environment over the next few years those numbers are going to be potentially very tough to come by. 

[ERICOPOLY]

Wouldn't that be excessive, about ~75% payout?  Anyone know off hand what the better banks (JPM, WFC) were approved for last year?

 

 

The other banks were employing a strategy of paying dividends while still needing to build capital.

 

BofA's strategy has been to rebuild capital first, then return everything in excess of that.

 

So a 75% payout is conservative in that it's not 100%.  Moynihan has stated that as some loans runoff they'll be able to put that money back to work in new loans, so therefore they don't need to retain anything at all for the business right now.

 

 

 

[ERICOPOLY]

Eric - Just curious.  Do you plan on holding much of your BAC position after it hits ~$20 or whatever your price target is?  Maybe as a source of income?

 

Apologies if you have been asked this before - 200+ page thread..

 

I have a lot of flexibility in that roughly 50% of my holding is in RothIRA where I can trade without tax consequences.  I want to diversify out of BAC when I can trade it for a roughly equivalent amount of distributable earnings in other high caliber businesses.  Right now the gap is just so wide.  Maybe that happens at $20, maybe the rest of the market will crash and it will happen at $13.  I don't know.

 

[ERICOPOLY]

Also, valueline predicts 90c for next year.  1.35 in 2015.  If management cannot make 1% RoA and 10% RoE with that deposit base by 2015, I would think they get fired.

 

It's going to be a function, in part, of where interest rates are.  NIMs are getting squeezed now and that's not anyone's fault.  If we are still in a ZIRP environment over the next few years those numbers are going to be potentially very tough to come by.

 

Moynihan though has stated that they can do 13% to 15% return on tangible book without getting any improvement from interest rates.

 

In other words, he is saying they are making 13% to 15% already, right now, as long as you can look through the elevated expenses.