Bank of America: Better Than Treasuries

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.

Comments

[Zack Miller:]

Dear SeekingAlpha editors:
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?

2008 May 21 07:11 AM

[CrossProfit_:]

Joe Blow aka Mr. Katsman,

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

2008 May 21 07:30 AM

[USER 118677:]

Well,,, June 4th will tell when they post what the DIV will be. Or will they wait till the next QTR to cut???

2008 May 21 08:08 AM

[CrossProfit_:]

User 118677,

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

2008 May 21 08:37 AM

[OJO Zafado:]

In the first place no common stock dividend is safe. You can see a year of these posts and blogs indicating that the common dividend on WB was "SAFE". Bloggers and posters scoffed at the idea WB would be forced to cut as they just recently did! BAC is by far the largest holding in my portfolio. $20K in bonds, $20K in BACPRE, $7.5K in MJH, and $5K in FBF-PrN. I would rather own the bonds and take the 5.9% they give me than the common. At least they are Med term notes and will mature at face value. At which time I can re-evaluate whether there is a stagflation or serious inflation. The interest payments are indeed "SAFE"! The BAC-PRE at 5.4% is not such a great yield on a preferred perhaps as the other non-adjustable issuances, but is indeed adjustable to LIBOR and even has a nice default rate built in, in the event LIBOR falls to the levels it currently sits at. The "E" sells at a huge discont to par! The 7.2% on the "SATURN" MJH is as the author says a very nice coupon. Exchange traded notes and Third Party Trust vehicles have a much better chance of being called on or near their first call dates. Perhaps though given the long maturity date I will be "stuck with" the 7.2%. As for the leftover from the Fleet Bank merger the FBF-PRN, it is very likely to get called in the next 2 years and sells so far below par as to provide a very decent 6.8 %.. If called there is going to be a very nice resultant capital gain. So I like BAC, I just do not and would not own the common in this on going re-definition of the banking business. Not since the days when Bonnie and Clyde "went into the banking business" have the common shareholders of banks been so badly fleeced. This time it is by the $800 suits. A POS like Kennedy Thompson is still hanging around as a board member of WB, after being outed as CEO, disgraced for his abysmal performance. As the author points out BAC has just floated another new preferred and at a very huge coupon premium to it's 20 year bond interest rate. Many fools continue to claim that the huge issuance of secondary offerings by ALL the banks are not dilutive to the common shareholder. Preferred means what it says! Before the commoners can belly up to the bar they must give way to the newbie line cutting owners of preferreds. The more of cash flow allocated to preferreds the less that is available to the common shareholder. Now there are mechanisms to pay out the new preferreds as an effective return of capital but in the end the common shareholder is the guy who is going to be squeezed. BAC has a huge credit card business. Another business that as CDOs and MBSs once did, currently looks quite profitable on paper. Merideth Whitney has indeed pointed to that business as a potential source for even more losses next year. Gasoline purchases as a percentage of credit card spending are rising dramatically. Most Americans reguard the family car's gas as a non-discretionary. Where does this lead? There may be some potential for capital gain in some of these banks over a longer term and the purchase of common shares in partial lots may be appropriate. You can not expect that dividends will be getting raised in the next several years. BAC common is not an appropriate "income investment" at all! It is a speculative asset that may indeed return a nice capital gain on the other side of the Emerald City. Only fools will buy this common stock, with out paying attention to and understanding what the men behind the curtains are up to with this on going floating out of +8% subordinated debt. This indicates that the situation has changed. You may want to change your mind in how you invest for capital gain as well as for income.

2008 May 21 08:38 AM

[CrossProfit_:]

OJO Zafado,

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

2008 May 21 09:04 AM

[User 68127:]

Investing in BAC for the dividend is idiotic. Two bucks off the stock price, and the dividend is "gone." When consumer loans and credit cards join mortgages in the ER, the stock goes lower. IF what you say about the dividend being secure is true, wouldn't you rather wait and get an 8% yield instead of 7% and spare yourself the capital loss?

2008 May 21 11:54 AM

[OJO Zafado:]

Cross Profit
`
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

2008 May 21 12:30 PM

[TA:]

I've been pounding the table for a while now on this and other financials. It's amazing how fear changes everything - 2 years ago, your 'dip' would have been a few bucks and you'd be forced to pay up for a quality bank.

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.

2008 May 21 03:57 PM

[mlimberg:]

CrossProfit, Dude, what the hell are you smoking?

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?

2008 May 21 04:10 PM

[CrossProfit_:]

OJO Zafado,

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

2008 May 21 04:47 PM

[Gerry Sullivan:]

BAC doesn't want to cut the dividend just as Citigroup and Wachovia didn't want to cut their dividends. What happens to the BAC dividend in the next 2-3 years is just something that isn't predictable.

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."

2008 May 22 07:26 AM

[investorslive:]

BSC what a dead duck - this market is heading into the gutter yet again

www.investorslive.com/...

2008 May 22 11:04 AM

[karchad:]

I'm suspicious of real high dividends. Without knowing much, it seems to me that a 7%+ dividend is way out of whack for a bank. Just raises red flags for me. As for the "dividend being safe" for a stock, yeah right, I have oceanfront land in Kansas for those who believe any dividend of a bank is "safe", and by the way, i'm bullish on the market, but still, dont throw caution to the wind!...

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!

2008 May 22 01:24 PM

[vaduz:]

high dividend equals high risk -- thats an everstanding easy equition.
all other thoughts are speculation

2008 May 23 09:12 AM

[buyitcheap:]

Between CFC, its own mortgage issues, plus its credit card delinquencies, this stock could see 18.

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.

2008 May 23 12:44 PM

[kdo:]

Here's the problem as I see it. I'd prefer BAC cut the entire dividend as should probably every bank. Banks should be protecting their capital at this stage, not paying it out. A lot of the banks with the bigger problems all had high payout ratios, because when 1) they lost money and 2) paid a bunch of money out the door, then 3) they were forced to raise capital at distressed prices. Protecting shareholders also means don't dilute them. It's absolutely ridiculous for banks to on the one hand to both pay money straight out the door that they had to raise expensively on the street. Everyone should cut their dividends and show their shareholders some real, honest respect. I think it's amazing at this stage that you think it's impossible that BAC would cut their dividend when so many other banks have been forced to. That payout ratio is a weakness in this environment.

2008 May 23 04:35 PM

[Professiona...:]

There is one thing lost in all of this conversation about dividends on common vs pfd. If I were a bank executive contemplating cutting dividends to common shareholders, for whom I theoretically work for, then without a doubt, I would also cut the dividend on the preferred at the same time. I don't care about preferred holders, and to the extent that cutting dividend to common and not to preferred would annoy common holders, why not cut the dividend to the preferred too? Save money and make it look fair at the same time - it's a no brainer from management's perspective.

2008 May 30 01:10 PM

[morosem:]

Preferred stock dividend rights are usually cumulative. If the dividend is not paid it accumulates from year to year.

2008 Jun 04 08:16 PM

[Deep Value:]

ProHFAnalyst,

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.

2008 Jun 05 11:00 PM