BAC Longs Already Know This

[ERICOPOLY]

Except that Wells Fargo only needs a 1% SIFI buffer, whereas BofA needs a 2% buffer.  That may change over time, but I think that's what is understood today.

[bmichaud]

I'm not comparing BAC and KO right now. I'm saying BAC at BV with a 10% ROE is the same as KO at 21 times earnings with a 40% ROE.

 

Parsad said he plans on holding BAC for much longer than two years. He also said he believes it will reach BV in two years, which implies he believes BAC is worth holding at BV, which further implies BAC will earn higher than its cost of equity. Thus I was curious what his thoughts were.

 

I think BAC's return on equity will be better than 10% after 2-3 years.  Why?  Because much of their earnings will be driven by a recovering housing market.  There is every reason to believe that once BAC gets their litigation issues out of the way, and their operating costs down to very efficient levels, they would entertain a price not much less than Wells Fargo relative to book. 

 

- Moynihan's model for BAC over the next five years is to copy the culture and customer-centric focus of Wells. 

- They have the deposit base and the mortgage business. 

- They also have a much more complete investment business than Wells. 

- The credit quality of their portfolio is improving every quarter. 

- Their operating efficiency should be on par with Wells over time.

 

When you have a CEO who truly puts his compensation aside to do the right thing for the business, you start to develop a culture that will permeate the ranks over time.  Compare Moynihan's compensation to Vikram Pandit's.  Look at what Moynihan had to work with and turnaround and look what Pundit had to work with...then compare their compensation.  That changes the way employees behave when the CEO does the stuff that no one else is willing to do.  I'm very keen on BAC, because I'm very keen on Moynihan...he's the intangible asset in the valuation that you guys aren't including in your calculations!  Cheers!

 

Well said!!

 

I like what you said about the investment business in particular. If JPM's belief that the next 10 to 20 years will see significant capital markets growth, then BAC's capital markets business will prove to be a highly valuable business going forward.

JPM_IB_Slide.pdf

[redskin]

I'm not comparing BAC and KO right now. I'm saying BAC at BV with a 10% ROE is the same as KO at 21 times earnings with a 40% ROE.

 

Parsad said he plans on holding BAC for much longer than two years. He also said he believes it will reach BV in two years, which implies he believes BAC is worth holding at BV, which further implies BAC will earn higher than its cost of equity. Thus I was curious what his thoughts were.

 

I don't understand why you are using BAC's price/book, but KO's price/earnings.  I would rather have BAC at 0.40 book with 10% ROE than Coke trading at 5X book and earning 40% on equity.

[DCG]

I own some BAC, but one of my main issues with the company is that pretty much everyone I know who has been a BAC customer despises the company.

[bmichaud]

I'm not comparing BAC and KO right now. I'm saying BAC at BV with a 10% ROE is the same as KO at 21 times earnings with a 40% ROE.

 

Parsad said he plans on holding BAC for much longer than two years. He also said he believes it will reach BV in two years, which implies he believes BAC is worth holding at BV, which further implies BAC will earn higher than its cost of equity. Thus I was curious what his thoughts were.

 

I don't understand why you are using BAC's price/book, but KO's price/earnings.  I would rather have BAC at 0.40 book with 10% ROE than Coke trading at 5X book and earning 40% on equity.

 

So would I. I'm just saying that the investments are equal with BAC trading at 10 times earnings (or 1 times book under a 10% roe scenario) with a 10% roe and KO at 21 times earnings with a 40% roe.

[Parsad]

Except that Wells Fargo only needs a 1% SIFI buffer, whereas BofA needs a 2% buffer.  That may change over time, but I think that's what is understood today.

 

Yes, today...that's why there is this tremendous discount.  But over time, that will be more comparable.  Wells is the model that everyone wants to be.  If Moynihan keeps plugging away, over time he will get there.  Cheers!

[ERICOPOLY]

Further, based on BAC's historical loss rate on repurchases  and the amount of loans still at less than 25 payments, there is a chance BAC could suffer further repurchases losses of greater than $15 billion. Right now BAC says "possible" losses are $5 billion - given that last year bac said possible losses were less than $10 billion and had to reserve for an additional $15 billion, IMO the market is right to question management on its assumptions.

 

Actually, the $5b estimate is for non-GSE claims.  The vast majority of the repurchase requests are from the GSEs -- the percentage is stated on page 34 of the 4Q11 earnings presentation.

 

From the 4Q11 earnings presentatio, page 34

"Estimated range of possible loss related to non-GSE representations and warranties exposure could be up to $5B over existing accruals at December 31, 2011"

 

 

[racemize]

Further, based on BAC's historical loss rate on repurchases  and the amount of loans still at less than 25 payments, there is a chance BAC could suffer further repurchases losses of greater than $15 billion. Right now BAC says "possible" losses are $5 billion - given that last year bac said possible losses were less than $10 billion and had to reserve for an additional $15 billion, IMO the market is right to question management on its assumptions.

 

Actually, the $5b estimate is for non-GSE claims.  The vast majority of the repurchase requests are from the GSEs -- the percentage is stated on page 34 of the 4Q11 earnings presentation.

 

From the 4Q11 earnings presentatio, page 34

"Estimated range of possible loss related to non-GSE representations and warranties exposure could be up to $5B over existing accruals at December 31, 2011"

 

Yes, I'm more worried about the GSE reserves.  I think they typically say they can't estimate it well so haven't fully reserved, which is worrisome to me.  However, I still think the discount more than makes up for it.

[ERICOPOLY]

Further, based on BAC's historical loss rate on repurchases  and the amount of loans still at less than 25 payments, there is a chance BAC could suffer further repurchases losses of greater than $15 billion. Right now BAC says "possible" losses are $5 billion - given that last year bac said possible losses were less than $10 billion and had to reserve for an additional $15 billion, IMO the market is right to question management on its assumptions.

 

Actually, the $5b estimate is for non-GSE claims.  The vast majority of the repurchase requests are from the GSEs -- the percentage is stated on page 34 of the 4Q11 earnings presentation.

 

From the 4Q11 earnings presentatio, page 34

"Estimated range of possible loss related to non-GSE representations and warranties exposure could be up to $5B over existing accruals at December 31, 2011"

 

Yes, I'm more worried about the GSE reserves.  I think they typically say they can't estimate it well so haven't fully reserved, which is worrisome to me.  However, I still think the discount more than makes up for it.

 

Anyhow, all parties (including GSE's) put together only requested a total of $17.33b last year.  At a 30% loss rate, that's $5.2b per year pace even if 100% of them are repurchased.  I think clearly 100% will not be repurchased.

 

And with each passing year these loans get more seasoned and the credibility of the repurchase request deteriorates.

[Kraven]

Further, based on BAC's historical loss rate on repurchases  and the amount of loans still at less than 25 payments, there is a chance BAC could suffer further repurchases losses of greater than $15 billion. Right now BAC says "possible" losses are $5 billion - given that last year bac said possible losses were less than $10 billion and had to reserve for an additional $15 billion, IMO the market is right to question management on its assumptions.

 

Actually, the $5b estimate is for non-GSE claims.  The vast majority of the repurchase requests are from the GSEs -- the percentage is stated on page 34 of the 4Q11 earnings presentation.

 

From the 4Q11 earnings presentatio, page 34

"Estimated range of possible loss related to non-GSE representations and warranties exposure could be up to $5B over existing accruals at December 31, 2011"

 

Yes, I'm more worried about the GSE reserves.  I think they typically say they can't estimate it well so haven't fully reserved, which is worrisome to me.  However, I still think the discount more than makes up for it.

 

I am not sure I understand your concern.  Are you concerned that they haven't fully reserved for it or that the losses can't be estimated properly?  They are certainly proceeding appropriately.  Note that losses can't be reserved unless they are both probable and the loss can be reasonable estimated.  I am not sure that either prong applies here and thus there is really nothing they are able to do.

 

As a separate point, others have mentioned that they wonder why BAC doesn't just settle the claims and move on.  In my view they will never do this on an aggregate basis.  They don't want to set the precedent for future lawsuits and would rather fight now while they aren't penalized for it (well, not penalized more than they have been).  That's not to say that they won't settle some things if they find it beneficial, but I wouldn't expect them to settle the majority of their disputes unless it's clear that they have essentially won.

[racemize]

I am not sure I understand your concern.  Are you concerned that they haven't fully reserved for it or that the losses can't be estimated properly?  They are certainly proceeding appropriately.  Note that losses can't be reserved unless they are both probable and the loss can be reasonable estimated.  I am not sure that either prong applies here and thus there is really nothing they are able to do.

 

I understand that it is hard to estimate.  However, it seems clear that the GSE liabilities will be higher than what is currently reserved, so I would rather that they go ahead and put some amount in--they would get it back if they were wrong.  For example, I don't know exactly how much car repairs or house repairs will be at any given moment, but I typically save some money for them anyway.  Regardless, I don't think they are allowed to do such reserving, but I would rather conservative approaches be allowed. 

 

Moreover, the fact that those losses will show up and haven't been reserved is what bothers me--i.e., that they have unreserved liabilities that could be substantial. 

[onyx1]

Further, based on BAC's historical loss rate on repurchases  and the amount of loans still at less than 25 payments, there is a chance BAC could suffer further repurchases losses of greater than $15 billion. Right now BAC says "possible" losses are $5 billion - given that last year bac said possible losses were less than $10 billion and had to reserve for an additional $15 billion, IMO the market is right to question management on its assumptions.

 

Actually, the $5b estimate is for non-GSE claims.  The vast majority of the repurchase requests are from the GSEs -- the percentage is stated on page 34 of the 4Q11 earnings presentation.

 

From the 4Q11 earnings presentatio, page 34

"Estimated range of possible loss related to non-GSE representations and warranties exposure could be up to $5B over existing accruals at December 31, 2011"

 

Yes, I'm more worried about the GSE reserves.  I think they typically say they can't estimate it well so haven't fully reserved, which is worrisome to me.  However, I still think the discount more than makes up for it.

 

Just to be clear, GSE R&W liabilities are fully reserved based on actual experience, including the precedents gained from recent settlements with FNMA and FHLMC.  This liability includes current as well as expected future claims, but is based on historical GSE behavior.  What keeps BAC from estimating a range of possible loss (comparable to the $5mm in non-GSE RPL) is that the GSEs have recently changed their behavior and are now claiming loans that were formerly ignored.  One example, the GSE's are now making claims on loans that have made 25 or more payments when for years they drew the line at 25.  BAC has been rejecting these incremental claims on account of bad logic and the GSE's inconsistency with past behavior.  When a loan is rejected, it stays in the reported amount of 'claims outstanding' until both the GSE and BAC agree that it is resolved, so we should expect to see 'outstanding claims' from the GSE continue to grow until a agreement is reached. 

 

I have no idea how this one will be decided, but with BAC halting loan sales to FNMA due to this changed behavior, it looks like to me like BAC is digging in for a long fight if necessary. 

 

BAC has $5.4bln in face amount of loans currently waiting for resolution for R&W claims with FNMA. Here is FNMA's take (from their Feb 2012 10-K):

 

"In the fourth quarter of 2011, Bank of America, the seller/servicer with which we have the most repurchase requests outstanding, slowed the pace of its repurchases. As a result of Bank of America’s failure to honor its contractual obligations in a timely manner, the already high volume of our outstanding repurchase requests with Bank of America increased substantially. Measured by unpaid principal balance, Bank of America accounted for approximately 52% of our total outstanding repurchase requests as of December 31, 2011, compared with 45% as of September 30, 2011 and 41% as of December 31, 2010, shortly after entering into an agreement with us to address its then-outstanding repurchase requests. Similarly, Bank of America accounted for 59% of our repurchase requests that had been outstanding for more than 120 days as of December 31, 2011, compared with 48% as of September 30, 2011 and 37% as of December 31, 2010. We are taking steps to address Bank of America’s delays in honoring our repurchase requests. For example, we did not renew our existing loan delivery contract with Bank of America at the end of January, which significantly restricted the types of loans it can deliver to us."

 

[racemize]

Just to be clear, GSE R&W liabilities are fully reserved based on actual experience, including the precedents gained from recent settlements with FNMA and FHLMC.  This liability includes current as well as expected future claims, but is based on historical GSE behavior.  What keeps BAC from estimating a range of possible loss (comparable to the $5mm in non-GSE RPL) is that the GSEs have recently changed their behavior and are now claiming loans that were formerly ignored.  One example, the GSE's are now making claims on loans that have made 25 or more payments when for years they drew the line at 25.  BAC has been rejecting these incremental claims on account of bad logic and the GSE's inconsistency with past behavior.  When a loan is rejected, it stays in the reported amount of 'claims outstanding' until both the GSE and BAC agree that it is resolved, so we should expect to see 'outstanding claims' from the GSE continue to grow until a agreement is reached. 

 

I have no idea how this one will be decided, but with BAC halting loan sales to FNMA due to this changed behavior, it looks like to me like BAC is digging in for a long fight in necessary.

 

do you have a reference for that reserve information (e.g., in the current 10-k)?  I just started on it and the section ~page 90 didn't seem very clear about what was reserved and what was not for GSE.

[onyx1]

Just to be clear, GSE R&W liabilities are fully reserved based on actual experience, including the precedents gained from recent settlements with FNMA and FHLMC.  This liability includes current as well as expected future claims, but is based on historical GSE behavior.  What keeps BAC from estimating a range of possible loss (comparable to the $5mm in non-GSE RPL) is that the GSEs have recently changed their behavior and are now claiming loans that were formerly ignored.  One example, the GSE's are now making claims on loans that have made 25 or more payments when for years they drew the line at 25.  BAC has been rejecting these incremental claims on account of bad logic and the GSE's inconsistency with past behavior.  When a loan is rejected, it stays in the reported amount of 'claims outstanding' until both the GSE and BAC agree that it is resolved, so we should expect to see 'outstanding claims' from the GSE continue to grow until a agreement is reached. 

 

I have no idea how this one will be decided, but with BAC halting loan sales to FNMA due to this changed behavior, it looks like to me like BAC is digging in for a long fight in necessary.

 

do you have a reference for that reserve information (e.g., in the current 10-k)?  I just started on it and the section ~page 90 didn't seem very clear about what was reserved and what was not for GSE.

 

See pages 55-62 and page 125 of the recent BAC 10-k

[racemize]

Just to be clear, GSE R&W liabilities are fully reserved based on actual experience, including the precedents gained from recent settlements with FNMA and FHLMC.  This liability includes current as well as expected future claims, but is based on historical GSE behavior.  What keeps BAC from estimating a range of possible loss (comparable to the $5mm in non-GSE RPL) is that the GSEs have recently changed their behavior and are now claiming loans that were formerly ignored.  One example, the GSE's are now making claims on loans that have made 25 or more payments when for years they drew the line at 25.  BAC has been rejecting these incremental claims on account of bad logic and the GSE's inconsistency with past behavior.  When a loan is rejected, it stays in the reported amount of 'claims outstanding' until both the GSE and BAC agree that it is resolved, so we should expect to see 'outstanding claims' from the GSE continue to grow until a agreement is reached. 

 

I have no idea how this one will be decided, but with BAC halting loan sales to FNMA due to this changed behavior, it looks like to me like BAC is digging in for a long fight in necessary.

 

do you have a reference for that reserve information (e.g., in the current 10-k)?  I just started on it and the section ~page 90 didn't seem very clear about what was reserved and what was not for GSE.

 

See pages 55-62 and page 125 of the recent BAC 10-k

 

So I went back and re-read those sections and then went to note 9--I guess the language in there isn't all that clear to me, or didn't lead me to reach the same conclusion.  This seems to be the relevant language (unless I'm missing something you noticed):

 

The liability for representations and warranties is established when those obligations are both probable and reasonably estimable.  For 2011, the provision for representations and warranties and corporate guarantees was $15.6 billion compared to $6.8 billion in 2010.  Of the $15.6 billion provision recorded in 2011, $8.6 billion was attributable to the BNY Mellon Settlement and $7.0 billion was related to other exposures.  The BNY Mellon Settlement led to the determination that the Corporation has sufficient experience to record a liability related to its exposure on certain other private-label securitizations.  This determination combined with higher estimated GSE repurchase rates were the primary drivers of the balance of the provision in 2011.  GSE repurchase rates increased driven by higher than expected claims during 2011, including claims on loans that defaulted more than 18 months prior to the repurchase request and on loans where the borrower has made a significant number of payments (e.g., at least 25 payments), in each case in numbers that were not expected based on historical claims.

 

Government-sponsored Enterprises

The Corporation’s estimated provision and liability at December 31, 2011, for obligations under representations and warranties given to the GSEs considers, among other things, and is necessarily dependent on and limited by, its historical claims experience with the GSEs. It includes the Corporation’s understanding of its agreements with the GSEs and projections of future defaults as well as certain other assumptions and judgmental factors. The Corporation’s estimate of the liability for these obligations has been accounted for in the recorded liability for representations and warranties for these loans. In recent periods, the Corporation has been experiencing elevated levels of new claims from the GSEs, including claims on loans on which borrowers have made a significant number of payments (e.g., at least 25 payments) or on loans which had defaulted more than 18 months prior to the repurchase request, in each case in numbers that were not expected based on historical experience. The criteria by which the GSEs are ultimately willing to resolve claims have changed in ways that are unfavorable to the Corporation. While the Corporation is seeking to resolve its differences with the GSEs concerning each party’s interpretation of the requirements of the governing contracts, whether it will be able to achieve a resolution of these differences on acceptable terms and timing thereof, is subject to significant uncertainty. The Corporation intends repurchase loans to the extent required under the contracts and standards that govern its relationships with the GSEs.

The Corporation is not able to predict changes in the behavior of the GSEs based on the Corporation’s past experiences. Therefore, it is not possible to reasonably estimate a possible loss or range of possible loss with respect to any such potential impact in excess of current accrued liabilities.

 

From the above, it seems as though the total reserves for GSEs is less than non-GSE.  It has been my understanding that the total potential GSE liabilities are more than non-GSE, and the reserves are actually the opposite, due to predictability.  That's what's driven my thought that there will be significantly more issues with GSE claims than non, which they have already indicated may be 5 billion short. 

 

However, I haven't finished reading the 10-K yet as I was mostly focused on AIG and other 10-ks for the past couple of weeks, so I would appreciate your insight if I am off.

 

 

Edit: is there a table where it breaks out the reps and warranties provisions, or is it just one lump sum everywhere?

 

[onyx1]

From the above, it seems as though the total reserves for GSEs is less than non-GSE.  It has been my understanding that the total potential GSE liabilities are more than non-GSE, and the reserves are actually the opposite, due to predictability.  That's what's driven my thought that there will be significantly more issues with GSE claims than non, which they have already indicated may be 5 billion short. 

 

Edit: is there a table where it breaks out the reps and warranties provisions, or is it just one lump sum everywhere?

 

The reserves between GSE's and non-GSE are not comparable for many reasons, but the biggest one is that the GSE reserves currently reflect the fact that a very large portion of the GSE R&W liabiliity has been settled and paid.  Not so with the non-GSE's since the NY court has not confirmed the BNY-Mellon agreement yet and reserves are still held until that happens.  Specifically, the GSEs have settled with BAC for:

 

1) FMCC, all CFC originated loans through 2008

2) FNMA, all CFC loans that were in the pipeline as of 9/20/2010

 

With CFC representing 76% of BAC's GSE originations the settlement with FMCC is significant.  The FNMA settlement leaves them some wiggle room.  GSE risk remaining are BAC/ML originated loans with FMCC, and all CFC/BAC/ML loan claims made after 9/20/2010 with FNMA. 

 

It's not a big suprise that FNMA is now expanding their threshold for claims since they settle based on pipeline contents on a specific date.  FMCC can't do the same since they settled on all CFC loans based on origination dates, but they can get expansive with BAC/ML loans.

 

The only breakout of the R&W liability I can find is on page 209 of the 10-K where they discuss $8.6 for BNY-Mellon, and $7.0 for everything else.

 

 

 

 

[racemize]

From the above, it seems as though the total reserves for GSEs is less than non-GSE.  It has been my understanding that the total potential GSE liabilities are more than non-GSE, and the reserves are actually the opposite, due to predictability.  That's what's driven my thought that there will be significantly more issues with GSE claims than non, which they have already indicated may be 5 billion short. 

 

Edit: is there a table where it breaks out the reps and warranties provisions, or is it just one lump sum everywhere?

 

The reserves between GSE's and non-GSE are not comparable for many reasons, but the biggest one is that the GSE reserves currently reflect the fact that a very large portion of the GSE R&W liabiliity has been settled and paid.  Not so with the non-GSE's since the NY court has not confirmed the BNY-Mellon agreement yet and reserves are still held until that happens.  Specifically, the GSEs have settled with BAC for:

 

1) FMCC, all CFC originated loans through 2008

2) FNMA, all CFC loans that were in the pipeline as of 9/20/2010

 

With CFC representing 76% of BAC's GSE originations the settlement with FMCC is significant.  The FNMA settlement leaves them some wiggle room.  GSE risk remaining are BAC/ML originated loans with FMCC, and all CFC/BAC/ML loan claims made after 9/20/2010 with FNMA. 

 

It's not a big suprise that FNMA is now expanding their threshold for claims since they settle based on pipeline contents on a specific date.  FMCC can't do the same since they settled on all CFC loans based on origination dates, but they can get expansive with BAC/ML loans.

 

The only breakout of the R&W liability I can find is on page 209 of the 10-K where they discuss $8.6 for BNY-Mellon, and $7.0 for everything else.

 

This helps my understanding quite a bit.  However, I believe the settlements only cover those directly sold from countrywide to the GSEs.  Additionally, the 10-k indicates that some of the new repurchase claims are still related to countrywide:

 

Table 11 highlights our experience with the GSEs related to loans originated from 2004 through 2008. Outstanding GSE claims increased to $6.3 billion, primarily attributable to $14.3 billion in new repurchase claims submitted by the GSEs for both legacy Countrywide originations not covered by the GSE Agreements and legacy Bank of America originations.

 

It would be nice if they would break out what percentage of the $1.1 trillion was covered by the agreements, but perhaps they don't know.