Bank Of America: Not All Assets Are Created Equal

| About: Bank of (BAC)

Summary

Bank of America's deferred tax position represents a very large portion of the company's book value.

A strong case can be made for discounting deferred tax assets when calculating value and future returns.

Getting comfortable with estimates inherent in financial reporting can help investors build more plausible projections.

In response to a reader's request, I have written the following article to try my best to 1) discuss Bank of America's (NYSE:BAC) very large deferred tax assets and 2) not be confusing.

As the case goes with most financial concepts, I have seen the different aspects of deferred tax assets argued both ways, but this is conceptually a simple accounting operation that is meant to serve a single purpose. In its most basic form, a deferred tax account measures the net asset and liability differences between tax and financial accounting. Because there are thousands of recipients with millions of regulations, it's impossible for financial reporting, or anyone, to calculate an accurate end-of-year bill. So, at the end of the day, we are left with millions of expenses and payments on thousands of tax filings that are summed up and compared to their corresponding financial line items; with the differences displayed as a deferred net tax position.

I envy no one responsible for the calculation of this number.

Here is a look at the balance last reported in the annual 10-K:

Per 10-K:

Net deferred tax assets, reported as a component of other assets on the Consolidated Balance Sheet, represent the net decrease in taxes expected to be paid in the future because of net operating loss (NOL) and tax credit carry forwards and because of future reversals of temporary differences in the bases of assets and liabilities as measured by tax laws and their bases as reported in the financial statements. NOL and tax credit carry forwards result in reductions to future tax liabilities, and many of these attributes can expire if not utilized within certain periods.

As a reference, this $32.3 billion asset represents:

  • 25.9% of Consolidated "Other Assets"
  • 0.15% of Total Assets
  • 20.2% of Tangible Common Shareholders' Equity
  • 3.19Xs 2013's Net Income to Common Shareholders

The good:

Most people citing this very large deferred tax asset like to reference the future tax savings that it potentially represents. This is essentially the only positive argument I have seen, and it's true, but I always get thrown off, because 1) it is already counted as an asset and 2) the future savings it represents came at the cost of past payments or losses that have already been accounted for, and assets that are making the bank absolutely no money.

The bad:

Let's think this through, the bank had to either 1) lose money or 2) pay money in the past for a deferred tax asset to show up on the books. This asset makes no money, and may not even be utilized fully in future periods due to expirations and potential changes in effective tax rates.

This being the case, I find it hard to fully value this line item in any calculation or model I use to determine what the bank is worth (my opinion). Devaluing this line instantly decreases book value and increases the price to book value. Some may have a hard time discounting value like I do, but why not insert a little margin of safety here? And those future savings are only going to result in the reduction of the deferred tax asset anyway. Unlike the prepaid portion of this asset that results from temporary timing differences, the Net Operating Loss (NOL) portion is only a result of not fully reporting past losses. Yes, it will lower future payments, but remember, the event that created it was already modified, and again, the estimated benefit that it created may not be completely realized.

Bottom Line

Investors trying to put a price tag on the amount they will pay for shares of Bank of America have several tricky line items to value. Even though deferred tax assets are on the positive side of the balance sheet, they represent "prepayments", possible future tax benefits and assets making the bank absolutely no money. This being the case, I personally discount them when calculating book value, and completely ignore them when trying to model future earnings, as I believe tangible earning assets are a better, more consistent tool. This may sound negative, because my book value is lower than the one reported, but it also means that I see increases in my return calculations. Comparing Bank of America's book to peers is a good indication of market favor, but I tend to believe returns mean more and discounting and/or completely ignoring this large asset can yield more consistent results, because doing so somewhat neutralizes the use of estimates - though I cede I am eliminating one estimate to create another. All is fair game when it comes to calculating value, and everyone is going to have a different opinion, I look forward to hearing yours in the comments section below. Thank you for reading!

Disclosure: I am long BAC through warrants. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.