Bank of America: Better Than Treasuries 20 comments
Crossprofit
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It makes no difference whether Bank of America (BAC) goes through with the Countrywide Financial (CFC) acquisition or not. It makes no difference whether the subprime mess is over, two thirds behind us or just beginning. It makes no difference whether or not Citi (C) will post another staggering loss next quarter or Lehman (LEH) is downgraded by another analyst. The bottom line is that BAC kept out of all the shenanigans as they were going on and now has the cash to go shopping for distressed competitors.
In fact, BAC's balance sheet is superior to the U.S. government's balance sheet. Long term investors who couldn't care less whether the stock trades up or down for the next year to five years should be seriously looking at BAC for one reason only - the 7.1% yield! Normally high yields preface either high risk associated with an inevitable negative reevaluation or sometimes prelude a dividend cut. Since neither is the case for BAC, long term investors should lock in this 7.1% coupon unless you suspect stagflation interest rates to set in within the next year or so.
The only caveat to the above assessment is the reason the market is discounting BAC. Some say it is because of the CFC deal, in which case we say ignore the chatter (Meredith Whitney). Others say that BAC is hiding bad news, to which we say, well, we don't think so. If they are doing so, they are hiding it well because we can't see it. Others say that we have just seen the beginning of the financial crisis and on the next round, all banks will take a hit as the consumer starts to default en mass. We say, maybe this will happen and maybe it won't, but even if it does, what are the chances that BAC will cut the dividend because of one, two or even three bad quarters? When we say bad quarters, we mean total loss washouts!
BAC can and most likely will continue to pay the dividend even if it has to borrow and go into debt like the Fed or as CEO Ken Lewis said "the bank's board might consider approving an offering of preferred stock before cutting its payout to stakeholders." As of now, BAC is churning a profit, albeit 77% less than last year, while the Fed is running a chronic deficit and trying to figure out who's the next sucker it can borrow from. Not to mention that the profit cut was due primarily to loss provisions that hasn't materialized yet.
So what's better; 2.5/3% on a Treasury or 7.1% (gross) on a BAC bond? Well, at $35.60 per share, it's almost like a bond.
Update: BAC announced yesterday (May 20) the sale of $2.7B preffered with a 8.2% dividend rate. It doesn't get much better than this.
Disclosure: This is the third time this year that BAC is trading in the $36 range with a 7+% yield. We have recommended to long horizon investment clients to add to long positions.
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This article has 20 comments:
Come on! How can someone possibly say that BAC has a stronger balance sheet than the US government?? It's meaningless b/c the government can always print more money and misleading for investors.
Sub-standard writing and sub-standard analysis. Who is this Cross Profit guy?
If this is some kind of payback for pointing out to SA readers all the inaccuracies in your previous articles, it would be wise not to self contradict yourself in your own comment...
"It's meaningless b/c the government can always print more money"
Precisely what the U.S. has been doing which is the equivalent of constantly and consistently diluting shareholder value.
As an aside, if you feel the need for 'revenge', don't link to your website - it's a dead giveaway.
CrossProfit
Logically BAC will want to establish a long term track record with its dividend payments so that in five years from now when the time comes for the preferred to become stock it will be worthwhile for shareholders. In other words, the 8.2% dividend on the preferred should be less than what shareholders of the common earned in both dividends and equity appreciation.
Also BAC will use this method to raise as much cash as it needs to grow its business and take advantage of any goodies that may come along due to the financial crisis. Since there is dilution to be factored in as well, the dividend doesn't get touched in order to assure the above.
Another way of looking at this is BAC is saying to shareholders of common that for the next five years we will see that you earn at least 8.2% on average per year. This is not as easy as it sounds and the only way to sort of guarantee the outcome is by paying a 7% dividend. The rest can be done through equity appreciation or a special one time dividend towards the end - if necessary.
If the 'borrowing' cost rises much above 8.2%, BAC will have to abandon this approach.
You may have noticed that this is about half of what Citi pays to borrow...
CrossProfit
Well said. The sole area we disagree on is whether or not BAC will want to stick it to the commoners. Being that today's preferred are tomorrows commoners, we say they won't. After all, they may want to do this again in seven or ten years from now, so why destroy a beautiful relationship?
As for WB, allow us not to comment about Thompson, however, talking about WB and BAC in the same breath is akin to talking about IBM and DELL as if they were the same. Both are classified as 'hardware' yet have totally different sources of income with totally different management styles. IBM is growing through smart acquisitions whereas DELL is attempting to squeeze out more from a stressed out consumer...get the analogy?
We don't particularly care for the WB/DELL strategy!
CrossProfit
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I do not own Tech except in a couple of mutual funds. Those funds are lightened up in these Jan effect through the Sell in May periods. I would not own Dell at all. WB is an aggregious example of how the "suits " in the board room have absolutely no reguard for common share holders. Management looks upon them as equity to be sold and sold out. For this reason I own BAC,JPM,C,&GS preferreds as an alternative to their bonds that now are grossly overvalued in terms of inflation risk both short and long term. I do not own any WB-PrS an example of this +8% insanity we are seeing in terms of these financials continuing to float out more and more debt securities at ever higher returns. Perhaps the benchmark for knowing when this credit/liquidity crisis is comming to an end will be when these commercial banks and Brokerage groups start floating out preferreds at lower not higher rates. The US Dollar is toast The only hope we have is for one of the remaining three stooges left in contention for the next leader of the Free Money World to even have a desire to turn things around. Watch the monthly TIC. If we get 2 more consecutive net declines or net loss of cash flows in then it will just pile on the dollar weakness. I agree that WB is crap as compared to BAC but that does not stop their common shareholders from posting on their Yahoo message board their contentions that the two companies are basically the same business model with the same fiscal soundness. As one of today's preferred owners of BAC I do not see any scenario where I would be converted into common shares. It is my expectation to get their stated dividends without the vagaries of their quarterly results impacting the payouts. I expect that some of my shares wil be redeemed at par at some point, at which time I will look at some other income play/opportunities. When my RBS-G was called in several years past the call date, I was able to find some great values in beaten down Canadian Coal, O&G trusts. Eventually the Ten year will get back to +/- 6% . There may be an opportunity to return to the Med term bond market for real risk and inflation adjusted returns. Ben the Dollar Slayer has let the genie out of the bottle and left himself with an empty 6 shooter. Two weeks ago Ben increased the TRCA from $75 Billion to $100 Billion to the ECB and SNB. That was followed by 3 more major European Banks reporting a combined +10 Billion in write downs the following Monday! The BOE is now sniffing around for a "little loan" as well from Ben to tide them over as they embark on a rate cutting campaign of their own in response to a weakening (world) economy. Not half so happy to have destroyed the US dollar and economy, the Dollar Slayer feels that as misery loves company it is now in his job description to export inflation world wide! I do not see how any of these issues supports the managements of the financials in permitting them to stand by their common shareholders. They are in the buisiness of saving their businesses not holding hands with bank share speculators. Speaking of the RBS they recently offered their common shareholders a rights offering for a common new issuance at a discounted price to raise equity. That is what constitutes having some concern for your common shareholders. Floating out 8% preferreds just fully dilutes them.
Eso, Timoteo Del Ojo Zafado
Now everythings cheap and everyone's scared(or in the case of some of the commentors - scaring others).
Of course no dividend is safe! Safe = 100% guarentee. No investment is safe either, not even the treasuries when you consider inflation. Precious commodities could collapse tomorrow and take your stocks with it. That's the way it works, accept it and move on.
Stories about the collapse of civilization were everywhere a few months ago and there's still plenty of bears waiting to pounce on the nearest fool.
We're going to wake up one Monday morning soon and see the same news about B of A as we saw about Bear Strearns...
Are you in over your head and hope that others will buy this dog?
Thanks for taking the time to spell out and share with us your perspective on the common. Again, it appears that we are for the most part in agreement except for the one point mentioned in our previous reply.
On that we shall have to agree to disagree!
Just food for thought; on the macro level, BAC management is beholding to the large institutional holders of the common. Mutual funds less so, as they tend to flip once a year. The reason to mention this is that the larger shareholders may not need to book profits on a quarterly basis, but do need to eventually show justification for holding a stock for five years. With BAC's cap size, institutional holders will not go quietly into the night as management erodes shareholder value.
There is an unspoken understanding governing the dynamics. The difference between the private investor and institutional holders is the breadth of time. This is why we explicitly pointed out the investment horizon factor in the article.
As an aside, there was a comment above saying something along the lines that $2 down and the coupon is wiped out etc. Obviously this is a novice investor that doesn't comprehend the discussion. (We apologize to the commentator for not replying as this would take considerable time to transcribe a reasonable coherent elucidation. However, we can suggest that you start by reading Roger Nussbaum's blog - "Random Roger" - see:
seekingalpha.com/autho....)
Eso,
Your point is well taken and understood to mean that due to erosion, there is a high likelihood that BAC PPS will remain suppressed for the long term, never to recover within the expected time frame. We just don't see that happening and respectfully leave it at that.
Thanks again,
CrossProfit
The US Treasury "cuts" the value of the US Dollar over time but
that isn't comparable to a dividend cut by a corporation.
I own BAC personally, but as an investor I understand that it might make more sense to own a bank that has already cut and been punished like Citigroup or a bank that is unquestionably stronger like
JPM Chase.
In the end it is like Ben Graham said about Mr. Market. He is open but you decide when/if you want to trade with him.
Like Warren Buffet says about Mr. Market, "he has incurable emotional problems."
www.investorslive.com/...
I prefer DVY, whose 4% dividend is truly safe because it's an ETF, and the only way the dividend gets cut is due to a price rise!
Any dividend north of 5% (non-REIT, that is), I'd do some serious due diligence on!
all other thoughts are speculation
Karchad - your statement regarding the DVY is a non sequitir. That's like saying a 4% cap gain distribution is safe because its a mutual fund. There is no correlation. The DVY is substantially financials, many of whom who will cut their dividend. Meanwhile you get a capital loss as the financials and other components of the DVY decline.
I totally agree. I would rather see BAC cut dividends than issue preferred stock. It's kind of like a "heads, existing shareholders lose a little... tails, existing shareholders lose a lot" deal. If BAC makes a spectacular turn around, shares get diluted. If the housing/credit markets keep sh*tting the bed we're stuck with an extremely high fixed cost.