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Osiris Farol

 
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  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    Thank you. If BAC gains $3 or $4 this year, we can proceed to party!
    Dec 30 09:36 AM | Likes Like |Link to Comment
  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    I can see the case for management to over-accrue. CEO Brian Moynihan commented to Reuters on 12/18 that the Fed wants the bank to show "consistent earnings" as part of the permissioning process for returning more capital to shareholders.

    Of course, much of the downside volatility in earnings has arisen from on-going provisions for legal risk, and a large one-time accrual could help to address this (since settlements or judgments could then be debited against the resulting reserve and not earnings).

    Against that, accounting standards allow the bank to accrue only for possible losses that are probable (or reasonably possible) and estimable. This means possible losses that are not estimable are not reflected on the balance sheet even though they may turn out to be material; in short, it is reasonably likely that the bank may turn out to have under-accrued relative to the ultimate liability.

    Management has signaled this by suggesting that losses could be up to $6bn more than the reserve, and added that even the reserve plus this additional amount does not represent an estimate for the "maximum loss exposure"
    Dec 29 10:30 AM | Likes Like |Link to Comment
  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    Thank you!

    The reply below is to the comment before yours, from MexCom.
    Dec 29 10:22 AM | Likes Like |Link to Comment
  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    I can see the case for management to over-accrue. CEO Brian Moynihan commented to Reuters on 12/18 that the Fed wants the bank to show "consistent earnings" as part of the permissioning process for returning more capital to shareholders.

    Of course, much of the downside volatility in earnings has arisen from on-going provisions for legal risk, and a large one-time over-accrual could help to address this (since settlements or judgements could then be debited against the resulting reserve and not earnings).

    Against that, accounting standards allow the bank to accrue only for losses that are probable (or reasonably possible) and estimable. This means possible losses that are not estimable are not reflected on the balance sheet even though they may turn out to be material; in short, it is reasonably likely that the bank may turn out to have under-accrued relative to the ultimate legal liability.

    Management has signaled this by suggesting that losses could be up to $6bn more than the reserve, and added that even the reserve plus this additional amount does not represent an estimate for the "maximum loss exposure".
    Dec 29 10:02 AM | Likes Like |Link to Comment
  • Bank Of America: Revisiting The Valuation Case [View article]
    If you accept the analysis, it is reasonable to expect over time a return on an investment in BAC shares of 15-20% per year; this assumes the bank generates an annual return on equity of 8-11% per year and takes account of the fact you are buying in at ~55% of book value. It also assumes that management does not engage in capital-impairing activities and that we can rely somewhat on the balance sheet including, in particular, the accruals for legal liability in the legacy mortgage business.

    Unfortunately, there is nothing in the analysis to suggest the stock gets to $20 in 2013.
    Dec 29 09:40 AM | Likes Like |Link to Comment
  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    Thank you and MilesSoldier for the feedback; I see what you mean and apologize for the confusion.

    The gist of the article is that BAC is highly capital-generative. In 2012, this supported a doubling of the stock price because, as capital accumulated on the balance sheet, investors likely became less concerned about the risk of a dilutive share issue.

    Looking forward to 2013, BAC will continue to generate capital but will no longer need to retain it all because its capital position already meets regulatory requirements (now and well into the future); in short, there will likely be significant excess capital.

    My expectation is that regulators will permit BAC to return some of this excess capital to shareholders in the form of stock buyback, and this will catalyze a re-rating of the stock from the current price of $11.3 higher towards book value which is currently $20.4.
    Dec 28 11:26 PM | 4 Likes Like |Link to Comment
  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    The stock price doubled from $5.6 at end 2011 to $11.3 today
    Dec 28 10:17 PM | 1 Like Like |Link to Comment
  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    It looks as though, in order to for a settlement to occur, there needs to be more clarity around whether MBIA can place its structured finance unit into rehabilitation or liquidation (thereby making it more difficult for policyholders such as BAC to collect on their claims) without adverse consequences for the parent. Unfortunately, I have not done the legal analysis on viability or timing and would welcome any insight.
    Dec 28 10:10 PM | 2 Likes Like |Link to Comment
  • Bank Of America: Expect Stock Buyback In 2013 [View article]
    I agree the litigation losses related to the legacy mortgage business could be meaningfully higher than accruals (of $16.3 billion for representation & warranty claims) even after grossing up for management's estimate of up to $6bn for possible losses above the accrual.

    Indeed, the bank's filings are clear that these numbers represent losses which are probable (or reasonably possible) and estimable. Possible losses which are not estimable are simply not included so that the numbers "do not represent a maximum loss exposure".

    Against that, the bank seems to have excess capital today and looks likely to generate substantial capital this quarter and in 2013. If we assume regulators would accept for now an 8.5% Tier 1 ratio (equal to JPM) under Basel 3, BAC's present excess capital is ~$7.5bn. Analyst EPS estimates for Q4 2012 and FY 2013 are 19c and 96c respectively representing additional capital of ~$12bn.

    In other words, assuming risk-weighted assets do not grow meaningfully as BAC continues to "optimize" the balance sheet, the bank either has or will generate nearly $20bn of excess capital through the end of next year. Even if litigation losses absorb $10bn of this (and so, given tax effects, come in at $15bn+ above accruals) there is still plenty available.
    Dec 28 09:28 PM | 1 Like Like |Link to Comment
  • Bank Of America: Revisiting The Valuation Case [View article]
    You have history on your side! Thank you for commenting on the note.
    Dec 28 03:00 AM | 1 Like Like |Link to Comment
  • Bank Of America: Revisiting The Valuation Case [View article]
    I agree there is earnings leverage at BAC as provisioning for legal matters (including mortgage repurchase) declines and cost-saves flow through. You probably remember that at the Investor Day in March 2010, CEO Brian Moynihan suggested earnings, before taxes and provisions, of $45-50 billion (albeit in a more "normal" interest rate environment). Even getting some of the way there could represent a meaningful lift over the ~$15 billion (annualized) for the first three quarters of 2012.

    I also expect that, following the regulatory stress-tests planned for early 2013, BAC will gain Fed permission to return capital to shareholders with an announcement possibly as early as March. If the stock still trades at a substantial discount to book value, stock buyback will be attractive and a likely catalyst for re-rating particularly if accompanied by a dividend increase.
    Dec 28 02:32 AM | 2 Likes Like |Link to Comment
  • Bank Of America: Revisiting The Valuation Case [View article]
    I agree there is balance sheet risk. For what it is worth, BAC passed the stress tests (results announced last March) suggesting it had the balance sheet strength to meet minimum regulatory capital standards in an "extremely adverse" scenario.

    Going forward, I expect BAC to request Fed permission to increase the dividend next year; if granted, this will provide some validation of the balance sheet and earnings power.
    Dec 27 09:40 AM | 2 Likes Like |Link to Comment
  • Bank Of America: Revisiting The Valuation Case [View article]
    Coincidentally, these are the four financial stocks I own although with most interest in BAC. The litigation risk around mortgages seems over-discounted if, as I believe, it accounts for much of the valuation gap with JPM.

    That said, the litigation risk is disconcerting. BAC has outstanding mortgage "representation and warranty" claims of ~$25bn against which it holds reserves of ~$16bn. Furthermore, new claims continue - to the tune of $5bn last quarter.

    BAC notes that many of the new and unresolved claims relate to mortgages on which borrowers have made many (>25) payments, and are presumably less viable than claims relating to mortgages where borrowers made few, if any, payments. However, these are technical issues for the attorneys and, without the resources to arrange a legal analysis, I prefer to diversify any BAC position.
    Dec 27 09:07 AM | 1 Like Like |Link to Comment
  • Bank Of America: Revisiting The Valuation Case [View article]
    I agree the balance sheet risk is high for large banks and, along with stiffer regulatory capital requirements, a key reason the stocks are trading at or below book value in notable cases. For BAC, in particular, there is significant incremental balance-sheet risk because of litigation around allegedly improperly-sold mortgages. This probably accounts for the fact that BAC is trading at 56% of book value versus 88% for, say, JPM.
    The protection available to owners of BAC securities is in the form of the bank's capital. For example, at the end of Q3, BAC had $135 billion of Basel 3 capital on $1.5 trillion of corresponding risk-weighted assets for a Basel 3 capital ratio of ~9%. This capital appears more than needed for BAC to follow a comfortable glide path to meet the minimum regulatory capital ratio of 7% plus a global-SIFI buffer as it phases in through 2019 (even if that buffer is set at the maximum of 2.5%).
    To give an idea of relative scale, BAC has suggested that its liability for allegedly improperly-sold mortgages could be $6bn higher than allowed for on the balance sheet. If this is indeed the worst case and adjusting for taxes, it would reduce the firm's capital ratio by less than 0.3% and not make a meaningful difference to the go-forward, long-run economics.
    Dec 26 07:43 PM | 2 Likes Like |Link to Comment
  • Bank Of America: Revisiting The Valuation Case [View article]
    You are right that the analysis is sensitive to the assumption for normalized asset returns. However, in the case of BAC, there is a significant margin-of-safety because you are buying in at a price-to-book value of ~55%.
    Specifically, the risk to the analysis is that normalized equity returns for BAC - and hence large banks in general - are meaningfully below 10%. Even if they are only 8%, however, the analysis suggests you get an annual return on your investment in BAC of near 15%.
    Assuming BAC operates with normalized leverage of 10x (versus the current 8x), this equity return translates to an asset return of 0.8% which is significantly below the historical average of 1.2%+ albeit significantly higher than the 0.2% reported for the first three quarters of this year.
    Dec 26 05:00 PM | 2 Likes Like |Link to Comment
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