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Goldman Sachs (GS) analyst Richard Ramsden says that the bigger banks have increased their earnings potential “mostly via long term accretive deals.” But Mr. Ramsden fails to recognize that the real driving force behind the recent process of accretion in the financial services industry thus far has been government aid and intervention, in one form or another.
On Monday, citing an improved earnings outlook, Goldman raised its call on Bank of America (BAC), and other Wall Street majors, to “attractive” from “neutral”. But that outlook is premised in the hope that even a weak recovery will result in a decisively positive credit and investment environment.
In this writer’s opinion, BofA is headed straight back into single digits; build short positions in the $17.50-$20 range, targeting a highly profitable exit by mid-2010.
BofA’s financial statements (six months ended June 30, 2009) certainly show that the bare foundations (namely capitalization and asset reclassifications) for a substantive enhancement in future earnings are in place. The real question, however, is this: has a qualitative turnaround been achieved in the bank’s interest and non-interest income, and will the debt servicing capabilities, today and in the foreseeable future, of BofA’s customer base keep loan-delinquency requirements in check over the next 2-3 quarters?
The US$36 billion provision (as of June 30, 2009) for credit losses may well support the integrity of capital adequacy ratios today. The income from investments and trading (roughly US$17 billion) reflects the pricing environment in the first half of 2009. But how will the V-shaped (or U-shaped) recovery impact BofA’s balance sheet during the course of next year? Already, hard data from the economy (including the jobless rate) is offering mixed signals, at best.
Goldman claims that BofA’s share price (US$16.75) “does not reflect the prospects for earnings growth.” Is the Goldman update simply a bet on an economic growth in the midst of an unwinding of record levels of actual and contingent intervention? Or, should we all be expecting to reap the rewards (yet again) of a second stimulus package?
This writer is not suggesting that BofA shares are due for any imminent collapse; too many institutional and retail investors are in wait-and-see mode. On the contrary, the slide into single digits will begin once analysts realize that, even if the IMF’s latest growth forecast (1.5% in 2010) comes to fruition, the economy will be unable to generate any compelling BofA-specific value drivers demanding upward revisions in the diluted EPS (0.75, as of June 30) or, for that matter, in any other measurement of value.
With $2,254 billion in assets, BofA is, in many respects, best-poised to gain from in sustained economic growth. But will there be any verifiable advances in home prices and family balance sheets in forthcoming months? If not, the accretion process Mr. Ramsden referred to could well be witnessed in reverse, exposing the weaknesses in Goldman’s “conviction buy list” of Wall Street banks.
In fact, the first shock waves for America’s big banks could possibly from a non-U.S. source early next year, when the pressure to service (i.e. refinance) $400 billion of corporate and bank debt (denominated in foreign currencies) in the emerging market wrecks havoc with lending spreads and credit quality.
Disclosure: Modestly short BAC; seeking to add above $18
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I have a question for you. I have been afraid to use ProFunds ultra bear or any other ETF/bear fund because I was convinced that the counter-party risk was too great. As you know the counter-parties are mostly the major banking and financial institutions. Do you think I am being too cautious? My second question concerns the price of oil. I have been thinking the price of oil should be around $30 to $35 per barrel. It appears I missed the reflation trade altogether. Or have I? Looking forward to your answers.
Careful with your levered bear funds in this market. The market retraces by 5% over the last few trading days and is now moving higher again in the face of a weakening dollar, sluggish retail sales forecasts for Q4, and higher inflation prospects (gold $1,035).
Fair value for the market has yet to be determined and much of where the market has been trading is predicated on a recovery. What is hard to determine is just what that "recovery" is predicated on...consumer spending? earnings recovery? A floor on depreciating assets? I can understand points 2 & 3 but without consumer spending any recovery could be short lived. The only saving grace would be that the consumer comes back into the market and starts spending again, and that the cross sections of that equilibrium meet at just the right time so that the corporations which have been cutting costs and the assets that have been depreciating are meet with a renewed consumer demand. If that were to occur at just the right time then the market could remain buoyant and potentially move higher. At the very least, it could prevent a market sell off.
The direction of the company and vision that Ken Lewis had (to create a company that was #1 in 3 areas...lending, deposits, and retail banking) could be lost with a new CEO. If the incoming CEO decides that they want to focus on other areas it could detract from shareholder value (if even for a short while). If the new CEO decides that they will pursue Ken Lewis' vision, how qualified is that person to deliver the goods?
Should this not be a determining factor in whether or not to invest in BAC at this juncture in time?
Careful with your levered bear funds in this market. The market retraces by 5% over the last few trading days and is now moving higher again in the face of a weakening dollar, sluggish retail sales forecasts for Q4, and higher inflation prospects (gold $1,035...points 1 & 3)).
Fair value for the market has yet to be determined and much of where the market has been trading is predicated on a recovery. What is hard to determine is just what that "recovery" is predicated on...consumer spending? earnings recovery? A floor on depreciating assets? I can understand points 2 & 3 but without consumer spending any recovery could be short lived. The only saving grace would be that the consumer comes back into the market and starts spending again, and that the cross sections of that equilibrium meet at just the right time so that the corporations which have been cutting costs and the assets that have been depreciating are meet with a renewed consumer demand. If that were to occur at just the right time then the market could remain buoyant and potentially move higher. At the very least, it could prevent a market sell off.
On Oct 06 10:10 AM David Braunstein wrote:
> Rakesh,
>
> I have a question for you. I have been afraid to use ProFunds ultra
> bear or any other ETF/bear fund because I was convinced that the
> counter-party risk was too great. As you know the counter-parties
> are mostly the major banking and financial institutions. Do you
> think I am being too cautious? My second question concerns the
> price of oil. I have been thinking the price of oil should be around
> $30 to $35 per barrel. It appears I missed the reflation trade altogether.
> Or have I? Looking forward to your answers.
Oil at $35 a barrel? BAC in single digits?
Anybody setting up their portfolio for this occurence better be employed or have another source of income because they're going to lose a lot of money.
Aside from that, if BAC does experience an "asset write-up" type of environment as the picture begins to look better going forward it will not be as a result of "profit GROWTH" it will be from precisely what you mentioned...an improving picture as it relates to asset appreciation, which is not "growth" in this environment. The growth that most investors look for is what stems from a normal business environment (revenue growth etc...).
And that is the concern here, where does "growth" come from when your entire business model is focused on the business of lending (which has been hampered by heightened reserve requirements)?
My suggestion is that BAC should eventually stop experiencing asset depreciation (if that has not already begun to occur). Soon there after profits will begin to arrise as they normally do in a healthy business environment...from increased revenue.
When these reserves do flow back to the company then you should expect a dividend hike almost immediately.
I think it is fair to say that much of the wealth destruction that occurred on BAC's balance sheet (and subsequently to the stock) happened as a result of a large shock to a specific category of loans (Real Estate). The biggest shock is presumed to be behind us now so a state of repair may be in order and thus the stock / company could experience a very immediate and large capital flow when the economy does find itself in better shape. This should send the stock higher...a lot higher.
On Oct 06 11:22 AM Tack wrote:
> $36B "may" support capital adequacy ratios? As the economy and realty
> improve, BAC could enjoy asset write-ups and become overcapitalized,
> and these reserves are likely to be released back into earnings,
> further enhancing BAC's profit growth
>
> Oil at $35 a barrel? BAC in single digits?
>
> Anybody setting up their portfolio for this occurence better be employed
> or have another source of income because they're going to lose a
> lot of money.
I think that ETF-related counterparty risks are minimal since, regardless of the counterparty, the "trust" mechanisms serve as protection.
Beyond the general view that oil is headed lower from current levels, I have can offer no specific insight into price targets at this time.
Many thanks - Rakesh
On Oct 06 10:10 AM David Braunstein wrote:
> Rakesh,
>
> I have a question for you. I have been afraid to use ProFunds ultra
> bear or any other ETF/bear fund because I was convinced that the
> counter-party risk was too great. As you know the counter-parties
> are mostly the major banking and financial institutions. Do you think
> I am being too cautious? My second question concerns the price of
> oil. I have been thinking the price of oil should be around $30 to
> $35 per barrel. It appears I missed the reflation trade altogether.
> Or have I? Looking forward to your answers.
On Oct 06 10:50 AM Greystone wrote:
> I have not looked at BAC's balance sheet so I can't speak to where
> it should be trading or if it is well positioned for the pending
> recovery. However, a big question for the direction of the company
> could lie with whomever takes over as the new CEO.
>
> The direction of the company and vision that Ken Lewis had (to create
> a company that was #1 in 3 areas...lending, deposits, and retail
> banking) could be lost with a new CEO. If the incoming CEO decides
> that they want to focus on other areas it could detract from shareholder
> value (if even for a short while). If the new CEO decides that they
> will pursue Ken Lewis' vision, how qualified is that person to deliver
> the goods?
>
> Should this not be a determining factor in whether or not to invest
> in BAC at this juncture in time?
Most analysts know this. As for revenue growth/profit generation, BAC is in excellent long term position. The countrywide business and Merrill should both contribute substantially to revenue generation and profitability. Substantial cost saves are very likely from integrating those two businesses.
BAC was one of the few companies that was hurt more then they were helped by the government. Lewis deserves blame for not raising much more capital before buying Merrill but government regulators should have told BAC that they couldn't do the Merrill deal without an immediate capital raise. Instead, the Fed and Treasury at a minimum nudged BAC into a deal and then they changed the rules of the game and pretty much forced them to raise capital when the stock price was depressed..
Remember BAC still owns plenty of shares of CCB. BAC should not raise the dividend much until most analysts start comparing their financial position and prospects favorable with JPM. Instead strengthen the balance sheet and buy back shares as long as the share price is below the low 30's
The FED pushed, not nudged, BAC into the ML deal. However, singling out any bank/financial institution as an exception to TARP would have caused panic in the eyes of depositors and investors of those companies that were required to take TARP rather than being the exception. The Fed would have created their own monster by imposing such a game plan because they would be responsible for picking up the pieces of all the institutions that suffered the wrath of the fear game.
I agree that BAC stands to benefit from potential synergies and eventual top line growth. As for ML & Countrywide, the most immediate impact those two acquisitions could have would be for the bloodshed to stop on write downs and losses. If they could stop being detractors that would be a first step toward recovery for BAC.
On Oct 07 10:03 PM wcinvest wrote:
> If BAC just has a mediocre quarter and the market stays up, the stock
> should immediately go to $20 a share. For quite some time, outgoing
> CEO has stated 3Q and the 4Q should be the most challenging for BAC.
> The 3Q won't benefit from one time items like last quarter did.<br/>
>
> Most analysts know this. As for revenue growth/profit generation,
> BAC is in excellent long term position. The countrywide business
> and Merrill should both contribute substantially to revenue generation
> and profitability. Substantial cost saves are very likely from
> integrating those two businesses.
>
> BAC was one of the few companies that was hurt more then they were
> helped by the government. Lewis deserves blame for not raising
> much more capital before buying Merrill but government regulators
> should have told BAC that they couldn't do the Merrill deal without
> an immediate capital raise. Instead, the Fed and Treasury at a
> minimum nudged BAC into a deal and then they changed the rules of
> the game and pretty much forced them to raise capital when the stock
> price was depressed..
>
> Remember BAC still owns plenty of shares of CCB. BAC should not
> raise the dividend much until most analysts start comparing their
> financial position and prospects favorable with JPM. Instead strengthen
> the balance sheet and buy back shares as long as the share price
> is below the low 30's
>