Great investors have an unusual ability to separate perception from reality. This ability may be applied to the analysis of entire companies and the individuals associated with them. Since people make investment decisions based on how they perceive the faces of companies, it is our job to question the investment community's perception of CEOs. For instance, I question Michael Mayo's assertion earlier this month that Brian Moynihan is the worst bank CEO in the United States.
As a Bank of America (BAC) shareholder, I stood behind Brian Moynihan when Wall Street criticized him. I will never know exactly why Wall Street pundits joked about Brian Moynihan while adoring Jamie Dimon, but I believe it may have been due to a tendency to judge CEOs based on superficial perceptions. I wonder how these analysts would have felt about Dimon and Moynihan had they focused more on actions and less on appearances.
For instance, they might have focused on how each CEO has managed the balance sheet of his respective bank: Jamie Dimon has grown JPMorgan Chase (JPM) over the last several years. Between the end of 2010 and the end of 2011, equity as a percentage of assets actually fell at JPMorgan Chase. In other words, Dimon increased leverage on the balance sheet.
|JPM||Equity (Billions USD)||Assets (Billions USD)|
The numbers suggest Jamie Dimon has not believed in deleveraging the JPMorgan Chase balance sheet through asset sales. He could have instead delevered the balance sheet by growing equity at a rate that was proportionally greater than the rate of liability growth, but he has not seemed committed to this either. The one thing Jamie Dimon has seemed committed to is the process of turning JPMorgan Chase into an even bigger bank (see below).
Contrast this with the actions of Brian Moynihan at Bank of America. Moynihan has managed to shed assets and reduce debt while growing shareholders' equity.
Moynihan has thus accomplished a reduction in leverage on the balance sheet and grown equity as a percentage of assets.
Equity (Billions USD)
Assets (Billions USD)
As investors, we need to consider how the market has priced in the performance of these CEOs. For years, analysts considered Jamie Dimon to be the benchmark by which all other bankers should be measured. Dimon's compensation exceeded that of other bankers and shares of JPMorgan Chase seemed to trade with a Dimon premium. Few questioned the wisdom of this--until recently.
For various reasons, the mark-to-market losses of the Chief Investment Office at JPMorgan Chase have been particularly embarrassing for Jamie Dimon. The disclosure of the loss at the Chief Investment Office has resulted in a loss of face for Dimon and a loss of market capitalization for JPMorgan Chase. The bank no longer trades at a premium to tangible book value.
Shares of JPMorgan Chase may be undervalued at current prices. Taken in isolation, the $2 Billion loss does not seem to justify the recent decline in the price of JPMorgan Chase shares. Rather, sellers are reacting to uncertainty over the final size of the loss and the resulting changes that will take place at the bank. Prior to the loss, the CIO's growth seemed to be accretive to EPS, but new information has the market questioning the value of the division. The uncertainty may lead to excessive selling, and patient investors with a strong constitution may thus find opportunity in shares of JPMorgan Chase.
Investors that see value in shares of JPMorgan Chase should consider Bank of America. Despite recent price declines in shares of JPMorgan Chase, shares of Bank of America still trade at a greater discount to tangible book value than do shares of JPMorgan Chase. Bank of America's market capitalization remains below both tangible and intangible equity, with a discount to tangible equity that far exceeds that of JPMorgan Chase.
Few large companies trade at such a phenomenal discount to tangible equity. An event this improbable is highly informative. Bruce Berkowitz talked about the reasons for such a discount in an interview with Wealthtrack's Consuelo Mack:
I think the naysayers just don't believe what Bank of America is saying. They believe bank of America is fibbing about the numbers, about the trends, about the strategy, about the model, about their ability to… I don't know.
But the good news is that that is what gives you a price of around 7 dollars a share for a company that could potentially earn 3 dollars a share. There aren't many times in life you can buy a storied franchise that touches one out of every two households in America for two and a half times what you expect their earnings are going to be in a more normal time.
Berkowitz makes a compelling case, yet many investors still balk. They feel uncertain about the true value of the assets on Bank of America's books. Fortunately, the Financial Accounting Standards Board has begun requiring banks to classify and report their hard-to-value assets. The FASB has broken down balance sheet assets into three categories: Level 1, Level 2, and Level 3; with Level 3 Assets being those "whose values are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement." In other words, banks need to report assets with decidedly hard-to-determine values as "Level 3" assets.
What many investors don't yet realize is that Bank of America has far fewer Level 3 Assets than competitors like JPMorgan Chase. According to an article in Fortune magazine, Bank of America has been the "most aggressive" out of all the big banks in lowering its hard-to-value assets.
Investors have not penalized other banks for having hard-to-value assets the way they have punished Bank of America. For example, Wells Fargo Corporation (WFC) trades at a premium to its book value, yet at the end of 2011 it had to classify about 13% of its assets as Level 3. JPMorgan Chase had to classify 5% of its assets as Level 3. Bank of America only had to classify 2.5% of its assets as Level 3. JPMorgan Chase would no longer trade under book value if it wrote down the value of its Level 3 assets, but Bank of America could give away all of its Level 3 assets tomorrow and it would still trade for less than book value.
Other skeptics focus on the Countrywide legacy. In April, Bloomberg published an article about Bank of America's Home Equity Loan Portfolio that appealed to such skeptics. In their first sentence they mentioned the fact that Bank of America's Home Equity Loan Portfolio exceeded its stock market value at the end of 2011. Citing a company filing, Bloomberg mentioned that the size of the Home Equity Loan Portfolio was $136.7 Billion. That figure still exceeds the market capitalization of Bank of America today.
We should not be scared by the fact that the size of this loan portfolio exceeds the stock market value of Bank of America. On the contrary, it should make us want to buy more shares. The Home Equity Loan Portfolio does not exceed Bank of America's market capitalization because it is too big. Rather, it exceeds it because Bank of America's market capitalization is far too low.
Bank of America could write down the entire value of this portfolio and still trade for less than the remaining equity on its balance sheet. This exemplifies how undervalued Bank of America remains today.
To summarize and conclude:
- Bank of America's CEO, Brian Moynihan, is an undervalued asset. He has done an excellent job directing the company since replacing Ken Lewis.
- Recent declines in the share price of JPMorgan Chase may attract investors, but those investors should instead consider Bank of America.
- Bank of America's discount to tangible and intangible equity still exceeds JPMorgan Chase's discount to its tangible and intangible equity, respectively.
- Investors have overstated the opacity of Bank of America's balance sheet. In fact, Bank of America's balance sheet appears to be more transparent than the balance sheets of other large banks.
- The amount of equity on Bank of America's balance sheet exceeds the company's market capitalization by a vast amount. This amount is so vast that they could take massive charges related to write-downs in their loan and mortgage portfolios and still trade under book value.
I created all of the charts and tables in this article. All of the numerical values in my charts are in billions of US dollars, unless otherwise stated. Asset and Liability values were taken from Forbes, i.e. here and here.
Disclosure: I am long BAC.