As BAC stock continues to fall, interesting perspective

[NormR]

Wow, a good deal of heat in this thread.  Rather unexpected for a value investing group.  Mind you, I'm having my doubts about some.

 

I wonder how many people are playing squash the hedge fund / mutual fund these days.  Paulson seems to have been a recent target and Fairholme seems to be a target.  I wonder how big their recent redemptions have been.  (It's mighty fine to have a stable capital base. :) )

[Rabbitisrich]

Here's my two cents.  I think bank stocks are down because their margins are starting to contract.  BAC, as one of the more troubled large banks, has suffered the most.

 

That's some of it; if you chart WFC's 1-year performance against the 2 year, 10 year constant maturity spread, you can see the correlation. In addition, NIMs are coming down for all the big banks, partly due to runoffs and partly due to the yield curve. That said, market pricing seems to excessively penalize certain forms of non-interest expense like legal, foreclosure and REO mititgation, and excess capacity. The market also distrusts loan loss reserves despite developments in delinquent inflow/outflow numbers since 3Q10.

 

 

[Munger]

Well I couldn't let the hilarious reference to Dick Bove go...  Dick on Lehman -- gotta love the guy...just coincidence but ironic that he made these comments in August of that year as well and the stock spiked because there were plent of believers...

 

And I'm not comparing LEH to BAC but I think you should listen to anything Dick Bove says w great caution...classic video.

 

http://video.cnbc.com/gallery/?video=828587679

[ERICOPOLY]

 

I would like to ask our friends from the MBIA board (valuecfa, Rabbitisrich, ERICOPOLY?) what would be their reaction with a $8b settlement? And MBIA's price has also been under pressure as MS, GS, C,... 

 

This is not about BAC and its MBS, it is about Europe and the potential ramifications of a credit freeze.

 

Also...

 

The day the $10b AIG lawsuit was announced, BAC stock was drilled and the pundits said it's because of the news of the AIG lawsuit.  But AIG's stock kept on dropping!

 

[rranjan]

"No, it just shows how a value investor thinks. First, downside protection."

 

You are now down 50% -- so much for the protection.

 

 

50% decline in stock quotation in last few months is being equated to no downside protection? Do you really think that way?

[stahleyp]

Were there any good investors in Lehman before bankruptcy(not a couple years before hand or anything crazy, of course)?

 

I know Einhorn was shorting it, but I don't know of anyone I respect who was in Lehman or Bear.

[Cardboard]

I know that BAC is getting a lot of attention these days, but have some of you done a comparative analysis with C?

 

It seems as cheap as BAC on a price to tangible equity and very close on a price to earnings standpoint. It is much better capitalized and much more profitable on ROE, ROA and pretax earnings to revenues. It has a fine international operation.

 

BAC only seems cheaper, and not by so much, on a price to book and price to 2012 forecasted EPS.

 

BAC stock price has dropped more and is now into the single digits which creates a lot of fanfare, but C might be a better deal at this point. Pandit has done a very good job and legacy issues have largely been removed from their financials. It is also much, much cheaper to buy options on C than BAC currently.

 

Cardboard

[moore_capital54]

Cardboard you have demonstrated in your post how illogical a scenario where BAC Fails is.

 

There is no way that C survives and BAC Fails. There is no way BAC fails and Barclays survives. Everything is so intertwined, the comparison of BAC to LEH is sophistry at it's worst.

 

 

[woltac]

Gentlemen,

 

Thank you for the lively debate.

 

A platitude is a trite, meaningless, biased, or prosaic statement, often presented as if it were significant and original.

 

Perhaps the bulls are relying to some extent on audited financial statements, a CEO with a past history of integrity who appears to be doing the right things, a change in the Fed's attitude about worst case results of the failure of large financial institutions, etc.  rather than platitudes.

 

I have no stake in this fight at the moment, but thanks to this thread I will do some research to determine if I should.

 

Thanks again,

 

woltac

[treasurehunt]

I know that BAC is getting a lot of attention these days, but have some of you done a comparative analysis with C?

 

It seems as cheap as BAC on a price to tangible equity and very close on a price to earnings standpoint. It is much better capitalized and much more profitable on ROE, ROA and pretax earnings to revenues. It has a fine international operation.

 

BAC only seems cheaper, and not by so much, on a price to book and price to 2012 forecasted EPS.

 

BAC stock price has dropped more and is now into the single digits which creates a lot of fanfare, but C might be a better deal at this point. Pandit has done a very good job and legacy issues have largely been removed from their financials. It is also much, much cheaper to buy options on C than BAC currently.

 

Cardboard

 

I did take a look at Citi's financials, but found it much more difficult to get a handle on its normalized earning power. Part of the problem has to do with so much of Citi's business being outside the US, where I don't have any familiar comparisons that I can make. Nevertheless, I did buy some C stock during the recent crash based mainly on two factors: one, the stock is trading at less than 60% of tangible book value, and I assume that Citi should be able to make a good enough return to be worth more than tangible book; two, management seems to be making excellent progress with whittling down the problematic assets in Citi Holdings, so chances of really unpleasant surprises that will reduce tangible book significantly are fairly low.

 

What is your estimate of the value of C stock?

[NormR]

Value investors snap up stocks in pummelled market

 

“This is a good time to buy, and not be afraid to average stocks down,” Francis Chou, founder of Toronto-based Chou Associates Management Inc. said Tuesday. “You cannot time the market.”

 

Mr. Chou, who recently pared the cash in his U.S.-focused Chou Associates Fund to 20 per cent from 30 per cent, has been buying U.S. financial stocks and retailers.

 

While he would not discuss specific purchases, his fund’s holdings at March 31 included warrants on Bank of America Corp. and Wells Fargo & Co. Warrants are options to buy a stock at a preset price.

 

Mr. Chou once avoided many U.S. banks because of their opaque financials and alarming use of derivatives, but he believes that the U.S. government is unlikely to let major financial institutions fail, while surviving banks will benefit from any economic recovery.

[Packer16]

A question for the bulls - how confident are you that BAC is similar to FFH (i.e. a stock that was punished but had management of impecable integrity that you could really trust)?  This stock sounds tempting but my historical weak spot has been leveraged financials and I would only invest in something like this if the management team was similar to FFH in actions.  Do you have examples of management putting shareholders in front of thier own interests?  TIA.  Note: historically, these bank turnarounds typically take quite a long time to happen (BAC from 1988 to early 1990s and C 1989 to early 1990s).

 

Packer

[alertmeipp]

A question for the bulls - how confident are you that BAC is similar to FFH (i.e. a stock that was punished but had management of impecable integrity that you could really trust)?  This stock sounds tempting but my historical weak spot has been leveraged financials and I would only invest in something like this if the management team was similar to FFH in actions.  Do you have examples of management putting shareholders in front of thier own interests?  TIA.  Note: historically, these bank turnarounds typically take quite a long time to happen (BAC from 1988 to early 1990s and C 1989 to early 1990s).

 

Packer

 

The problem is there is some perceived risk out there that thinks BAC will need to deal with 100-200b worth of mortgages put-back. If that's the #s and BAC needs to pay in a short time frame, then BAC needs to raise capital. I think the # is way too high (but no one can say for sure until it's all settled). But the time frame - come on.. it will take years...

 

It's like BP after the spill, ppl are yelling BP needs to file BK to pay back 10s of billions. What now?

 

[txlaw]

The CDS market moves hand in hand with the bond market which is obviously huge.  BAC's credit default awaps can't widen to those levels without their corporate bonds widening to the same levels.  So it's hard/impossible to manipulate in this case.

 

I'm not sure I understand this.  I mean, I get why the CDS spread and the interest rates for the underlying credits would move in the same direction.

 

But why is it the case that the corporate bond market actually prevents CDS spreads from getting out of whack on a temporary basis?  Is it because there is some sort of rapid arbitrage going on? 

 

Does anyone who has actually traded a CDS want to chime in?

 

Yes, you can arb it.  But I'll let someone who actually trades CDS corroborate this.

 

You can arb it with a basis trade. One basic example is, if the CDS protection is selling "too cheap," you buy the underlying bond and buy the CDS protection, lever it to high heaven, and collect the difference no matter what happens. (Because whether they default or not, you're made whole.) This is the "negative basis" trade - the CDS spread minus the bond spread is a negative number (you can do a positive basis trade but it's harder because you're shorting the bond). The trade is complicated even without leverage: technicalities of a "default" w/r/t the CDS paying off, interest rate exposure still exists, counterparty risk, etc...but you can do it. So there is active arbitrage that usually keeps the spreads on the bonds and on the CDS protection tight.

 

But both the price of the bond and the CDS are still set by market forces, which means anything can happen in the short run if you have forced buying or selling. For example, during the crisis, the basis blew out for junk bonds, which means if you had a leveraged position in the basis trade, you were in trouble.  Here's a good chart:

 

http://www.acredittrader.com/wp-content/uploads/2009/03/basis1.jpg

 

So yes, you can arb it, but there's no free lunch, and there are circumstances where the spreads do not move in lockstep.

 

Just saw this.  Thanks for the response, coc.

[Junto]

A question for the bulls - how confident are you that BAC is similar to FFH (i.e. a stock that was punished but had management of impecable integrity that you could really trust)?  This stock sounds tempting but my historical weak spot has been leveraged financials and I would only invest in something like this if the management team was similar to FFH in actions.  Do you have examples of management putting shareholders in front of thier own interests?  TIA.  Note: historically, these bank turnarounds typically take quite a long time to happen (BAC from 1988 to early 1990s and C 1989 to early 1990s).

 

Packer

 

I don't see it as an overnight turnaround by any means and I am getting more comfortable with management as time has moved along even though the stock price has gone lower. I think Moynihan is taking the right actions; pulling back on international credit card lending, trimming non-core investment stakes in Blackrock and potentially China Construction Bank. The bank will shrink itself to meet capital requirements in my worst case scenario.  Here is a synopsis on Moynihan from Fortune in July  if you haven't seen it already (http://bit.ly/nVlGTl). This is a quote I like from the article:

 

But Murray and Moynihan shared the same philosophy on making deals. They concentrated on extremely complex transactions, and they liked to pay cash. The reason was simple: The tangled deals scared off other potential bidders, allowing Fleet to buy on the cheap. Mike Lyons, who now heads strategy at BofA, worked on Moynihan's team for two years in the mid-1990s. "Brian would use a strategy we called 'hanging around the hoop,' " says Lyons. He'd make a low-ball offer on a complex deal and wait while all the other bidders dropped out, then low-ball again. That strategy worked brilliantly with the purchase of NatWest's U.S. business in late 1995. The ailing British bank's investment bankers, Goldman Sachs (GS), handed Moynihan a letter with the asking price. Moynihan whipped out a pen, crossed it out, and wrote in a drastically lower number. He got his price.

 

After completing an acquisition, Moynihan and his team would swoop down on the credit card unit or broker, analyze the business, then decide which parts of it to sell, grow, and fix. Recalls Lyons: "Brian would examine every asset, including securities, land, buildings. He'd do an assessment of what it's worth and what we should do with it."

 

The crowning deal for Murray and Moynihan was Fleet's $16 billion acquisition of BankBoston in 1999. It was a landmark moment in New England. BankBoston, founded in 1784, had dominated banking in the region for decades. Once again, it was Moynihan who turned a complex twist to Fleet's advantage. The Justice Department required that Fleet sell 280 branches in New England. Strong buyers lined up, including Chase and RBS Citizens. But Murray and Moynihan wanted to keep powerful rivals out of their territory. "The point was to find absolutely the worst operator possible," says an investment banker whose client wanted to buy the Fleet branches. Moynihan arranged to sell them to a weakling, Sovereign Bank. FleetBoston quickly won back old customers from Sovereign.

 

In a brief analysis, say they need to raise $25 billion at $5/share. That would be 5 billion shares to add to the existing 10 billion and result in a tangible equity of $8.47/share. The earnings power would decrease as well, but given analyst estimates of $1.48/share on average, the new estimate would be $1.00/share. It is still trading at six times next year's estimates. Let's say they can accomplish a stabilized 1% ROA, you are looking at $1.50/diluted share after the capital raise.  Stock is at four times stabilized earnings.

 

This is just a brief. I think there is enough downside protection at just over $6.00 to make this extremely compelling at these levels if you can be comfortable with unknown put back risk and Euro  issues that will play out over the next few years.

[Guest Hester]

Were there any good investors in Lehman before bankruptcy(not a couple years before hand or anything crazy, of course)?

 

I know Einhorn was shorting it, but I don't know of anyone I respect who was in Lehman or Bear.

 

Bill Miller....

 

Just kidding, there were no good investors in Lehman.

[S2S]

Were there any good investors in Lehman before bankruptcy(not a couple years before hand or anything crazy, of course)?

 

I know Einhorn was shorting it, but I don't know of anyone I respect who was in Lehman or Bear.

 

Bill Miller....

 

Just kidding, there were no good investors in Lehman.

 

I'm going to pretend there weren't a survivor bias here.  ;)

[given2invest]

A question for the bulls - how confident are you that BAC is similar to FFH (i.e. a stock that was punished but had management of impecable integrity that you could really trust)?  This stock sounds tempting but my historical weak spot has been leveraged financials and I would only invest in something like this if the management team was similar to FFH in actions.  Do you have examples of management putting shareholders in front of thier own interests?  TIA.  Note: historically, these bank turnarounds typically take quite a long time to happen (BAC from 1988 to early 1990s and C 1989 to early 1990s).

 

Packer

 

I don't see it as an overnight turnaround by any means and I am getting more comfortable with management as time has moved along even though the stock price has gone lower. I think Moynihan is taking the right actions; pulling back on international credit card lending, trimming non-core investment stakes in Blackrock and potentially China Construction Bank. The bank will shrink itself to meet capital requirements in my worst case scenario.  Here is a synopsis on Moynihan from Fortune in July  if you haven't seen it already (http://bit.ly/nVlGTl). This is a quote I like from the article:

 

But Murray and Moynihan shared the same philosophy on making deals. They concentrated on extremely complex transactions, and they liked to pay cash. The reason was simple: The tangled deals scared off other potential bidders, allowing Fleet to buy on the cheap. Mike Lyons, who now heads strategy at BofA, worked on Moynihan's team for two years in the mid-1990s. "Brian would use a strategy we called 'hanging around the hoop,' " says Lyons. He'd make a low-ball offer on a complex deal and wait while all the other bidders dropped out, then low-ball again. That strategy worked brilliantly with the purchase of NatWest's U.S. business in late 1995. The ailing British bank's investment bankers, Goldman Sachs (GS), handed Moynihan a letter with the asking price. Moynihan whipped out a pen, crossed it out, and wrote in a drastically lower number. He got his price.

 

After completing an acquisition, Moynihan and his team would swoop down on the credit card unit or broker, analyze the business, then decide which parts of it to sell, grow, and fix. Recalls Lyons: "Brian would examine every asset, including securities, land, buildings. He'd do an assessment of what it's worth and what we should do with it."

 

The crowning deal for Murray and Moynihan was Fleet's $16 billion acquisition of BankBoston in 1999. It was a landmark moment in New England. BankBoston, founded in 1784, had dominated banking in the region for decades. Once again, it was Moynihan who turned a complex twist to Fleet's advantage. The Justice Department required that Fleet sell 280 branches in New England. Strong buyers lined up, including Chase and RBS Citizens. But Murray and Moynihan wanted to keep powerful rivals out of their territory. "The point was to find absolutely the worst operator possible," says an investment banker whose client wanted to buy the Fleet branches. Moynihan arranged to sell them to a weakling, Sovereign Bank. FleetBoston quickly won back old customers from Sovereign.

 

In a brief analysis, say they need to raise $25 billion at $5/share. That would be 5 billion shares to add to the existing 10 billion and result in a tangible equity of $8.47/share. The earnings power would decrease as well, but given analyst estimates of $1.48/share on average, the new estimate would be $1.00/share. It is still trading at six times next year's estimates. Let's say they can accomplish a stabilized 1% ROA, you are looking at $1.50/diluted share after the capital raise.  Stock is at four times stabilized earnings.

 

This is just a brief. I think there is enough downside protection at just over $6.00 to make this extremely compelling at these levels if you can be comfortable with unknown put back risk and Euro  issues that will play out over the next few years.

 

Didn't we think this was all over after 2008/09?  What's to say this is the end of the crisis?  I just don't understand how after they raised lots of capital in 09 they now might need to raise lots more.  They've had 2 years of earnings to "grow" out of the losses.  Why should we believe this is the end?    (I ask honestly, I don't know a lot about financials.) 

[Kiltacular]

First, this goes down for funniest mock exchange of the year:

 

"For example...If a cup of coffee spills while reading the newspaper!

 

Your reality:  The coffee will stain the table, which will have to be resurfaced, lacquered and then restained to match...if you can even save the table at all! 

 

Reality:  you simply wipe it up with a cloth, refill the cup and read the newspaper again."

 

--

 

Second, some entertaining numbers from an atricle in tommorrow's WSJ:

 

link to full article (sub req): http://online.wsj.com/article/SB10001424053111904279004576526923038008308.html?mod=WSJ_business_whatsNews

 

"In a twist that may show how thin trading is at the end of the summer, bond investors have more concerns about Bank of America's near-term financial health than they do about its longer-term outlook.

 

Investors continue to pay more to insure against default for one year than they are for five years. In bond markets, investors typically pay more to insure against longer-term debt.

 

Trading in the five-year insurance contracts illustrated trading volatility around the bank. The cost opened at about $390,000 on Tuesday and then surged to $435,000 about 9:30 a.m. But by lunch, the cost was falling. It traded at about $380,000 in the afternoon, below the $386,000 closing high set in 2009.

 

By comparison, the cost to insure Bank of America debt for one year hit a high of $525,000 annually for every $10 million and remained elevated at $450,000 at the end of the day, according to Markit.

 

"It doesn't seem to compute but this is how the markets are feeling right now," said Mr. Hendler. He said that "negative perceptions are rocking the stock and [swap] prices."

 

They've got enough cash, for sure, to cover any debt coming due within a year so the conceivable argument that the CDS might be showing this based on the (wrong) idea that if they make it for a year, they can more easily make it for five years does not make sense.

 

I don't know the exact interplay here -- that is, exactly how this game is being played but I feel confident there's a game here.

 

Given that, as others mentioned before, BoA can prevent the effects of a bank run because they can fund their liabilities by trading assets to the FED means that this thing appears to be unkillable in their current post apocolypse banking world. 

 

 

[Parsad]

Gentlemen,

 

Thank you for the lively debate.

 

A platitude is a trite, meaningless, biased, or prosaic statement, often presented as if it were significant and original.

 

Perhaps the bulls are relying to some extent on audited financial statements, a CEO with a past history of integrity who appears to be doing the right things, a change in the Fed's attitude about worst case results of the failure of large financial institutions, etc.  rather than platitudes.

 

I have no stake in this fight at the moment, but thanks to this thread I will do some research to determine if I should.

 

Thanks again,

 

woltac

 

+1!  Cheers!

[Parsad]

Didn't we think this was all over after 2008/09?  What's to say this is the end of the crisis?  I just don't understand how after they raised lots of capital in 09 they now might need to raise lots more.  They've had 2 years of earnings to "grow" out of the losses.  Why should we believe this is the end?    (I ask honestly, I don't know a lot about financials.)

 

Two years is nothing.  It took Prem five years and a homerun on the credit default swaps to get FFH turned around.

 

A question for the bulls - how confident are you that BAC is similar to FFH (i.e. a stock that was punished but had management of impecable integrity that you could really trust)?  This stock sounds tempting but my historical weak spot has been leveraged financials and I would only invest in something like this if the management team was similar to FFH in actions.  Do you have examples of management putting shareholders in front of thier own interests?  TIA.  Note: historically, these bank turnarounds typically take quite a long time to happen (BAC from 1988 to early 1990s and C 1989 to early 1990s).

 

Hi Packer, there are no guarantees, but alot of the little things Moynihan is doing seems to be the correct path to choose.  Prem had a long history we could reflect back on as a CEO, so I think people had a better idea of his ethics and leadership skills.  Bank turnarounds vary, but this one could take a bit of time.  As mentioned above, it took Prem five years to turn around Fairfax, and I think it would take no less for Bank of America.  But the market notices things much earlier and usually reflects it in the price before the turnaround is complete.

 

In regards to Moynihan, he's not making moves for the sake of change, but liquidating portions of the business that aren't core...simplifying!  The executive compensation seems strongly tied to improvement in shareholder value and the longer term prospects for the company.  He knows the business inside out, and understands what are the strengthes of his competition.  Also has a good grasp of the company's brand, reach and exactly where they can maintain or grow market share.  Finally, he's got an impressive grasp of the banking business in general, as well as an excellent understanding of financials and seems to be a decisive leader.  It certainly has risk, but it's priced with that risk in mind.  Cheers!

 

 

 

[tombgrt]

I would like to thank everyone for this great topic, very educative.

 

Could anyone explain what would happen to the BAC warrants if (hypothetically) BAC was acquired by another bank?

[Uccmal]

tombgrt, Somewhere in the ether is a prospectus of the warrants.  I'd rather not guess since I read it months ago.

 

I dont see acquisition happening.  They are too big.  Re-cap is the more likely scenario if it came to that.  There are plenty of private investors who would lend for a higher yield than treasuries. 

 

Other options include partitioning Countrywide - I suspect this is what Moynihan has met with the regulators about, or selling more assets.  The government doesn't want any major bank failures and will do everything in their power to stop it.  Low interest rates and QE programs are specifically to bolster bank balance sheets to facilitate lending. 

[tombgrt]

Thanks Uccmal, I'll look for that prospectus and try to find the answer there. :)

 

The BAC-WTA at $2,97 with a strike price of $13,30 in 2019 really makes we want to have a closer look at BAC. Such plays will always be a bet in some way as there is no way that you can calculate IV accurately. However, when you buy the warrants your downside is limited just as much as with common stock (=zero). The only difference is that with common stock you will have lost a lot more capital in case that happens (highly unlikely but oke). Above a certain price the warrants will turn out to be extremely lucrative when bought at current prices.

[valuecfa]

A trader just sent me an detailed email that there is a new rumor being floated JPM may buy BAC with the help of treasury. This is how things start...it's just a rumor that I imagine is floating across the trading desks this am. I don't buy it but thought I would pass it along