As BAC stock continues to fall, interesting perspective

[Munger]

"Bank of America’s bond-insurance prices last week surged to a rate of $342,040 a year for coverage on $10 million of debt, above where Lehman Brothers Holdings Inc. (LEHMQ)’s bond insurance was priced at the start of the week before the firm collapsed." -- Bloomberg

[given2invest]

http://www.zerohedge.com/news/bank-america-cds-hits-escape-velocity

[txlaw]

Here's something I've been wondering since the financial crisis. 

 

Does activity in the CDS market affect the way that the underlying credit's common stock trades because the CDS market is used as an input in the algorithms used by HFT firms?  Bond traders seem to believe that the CDS market is smarter than the stock market.  If that is the case, it seems probable that any movement in the CDS market would be incorporated into the algorithmic trading of equities.

 

The follow up question is how liquid is the CDS market, and is it possible to cause wild swings for a particular credit using a small amount of money in favor of a much larger long or short equity position by exploiting any linkages between the CDS market and the stock market? 

 

Does anyone have any insight on this?  This is a legit question, btw -- I'm not a conspiracy theorist by any stretch of the imagination.

[given2invest]

The CDS market moves hand in hand with the bond market which is obviously huge.  BAC's credit default awaps can't widen to those levels without their corporate bonds widening to the same levels.  So it's hard/impossible to manipulate in this case.

 

 

[ubuy2wron]

Here's something I've been wondering since the financial crisis. 

 

Does activity in the CDS market affect the way that the underlying credit's common stock trades because the CDS market is used as an input in the algorithms used by HFT firms?  Bond traders seem to believe that the CDS market is smarter than the stock market.  If that is the case, it seems probable that any movement in the CDS market would be incorporated into the algorithmic trading of equities.

 

The follow up question is how liquid is the CDS market, and is it possible to cause wild swings for a particular credit using a small amount of money in favor of a much larger long or short equity position by exploiting any linkages between the CDS market and the stock market? 

 

Does anyone have any insight on this?  This is a legit question, btw -- I'm not a conspiracy theorist by any stretch of the imagination.

Every price movement in every security is affecting the price of every other security almost instantly because of algo and HFT trading the closer the securities in the relationship the larger greater the impact. The seller of the CDS has to hedge the exposure some of the trades in the CDS are hedged with the stock. No-one has been charged with insider trading through CDS transactions ,you should be a conspiracy thorist ,I am certain that lots of illegal or at least questionable activity is conducted through the CDS mkt.

[moore_capital54]

I think it should be illegal to buy a CDS on a naked basis. With BAC its funny to see these retards driving up the CDS prices. I cannot fathom any scenario short of a world war, where the federal reserve would allow BAC to fail. 

[Santayana]

They don't necessarily have to fail to trigger the CDS. 

 

What should be illegal is selling the CDS without adequate capital behind it a la AIG.

[Kiltacular]

The CDS market moves hand in hand with the bond market which is obviously huge.  BAC's credit default awaps can't widen to those levels without their corporate bonds widening to the same levels.  So it's hard/impossible to manipulate in this case.

 

Can anyone with access to bloomberg tell us where their bonds are trading? 

[given2invest]

The CDS market moves hand in hand with the bond market which is obviously huge.  BAC's credit default awaps can't widen to those levels without their corporate bonds widening to the same levels.  So it's hard/impossible to manipulate in this case.

 

Can anyone with access to bloomberg tell us where their bonds are trading?

 

CDS are just the cost to insure debt so by definition the debt will trade at the same levels as the CDS.  CDS did not put AIG into insolvency nor did they put any banks under.  Insolvent banks are insolvent.  By the way, I have never purchased a CDS.  I'm just a regular dude with a yahoo finance account. 

 

[rogermunibond]

Pretty much the only large financial trading at a discount.  You can see FINRA data at investingbonds.com

 

 

08/22/2011

17:59:56 BANK AMER CORP SUB INTERNOTES BOOK ENTRY

06050XVU4 5.300

09/15/2030 82.650

6.949 15K

 

08/22/2011

17:59:02 BANK AMER CORP SUB INTERNOTES BOOK ENTRY

06050XDP5 6.700

12/15/2026 97.450

6.972 9K A

 

08/22/2011

17:57:28 BANK AMER CORP SUB INTERNOTES BOOK ENTRY

06050XRA3 6.250

06/15/2029 92.500

6.987 10K A

 

08/22/2011

17:48:14 BANK AMER CORP SUB INTERNOTES BOOK ENTRY

06050XUA9 5.250

03/15/2020 91.800

6.514 5K A

 

08/22/2011

17:48:14 BANK AMER CORP SUB INTERNOTES BOOK ENTRY

06050XQJ5 6.000

05/15/2024 94.050

6.700 5K A

 

08/22/2011

17:47:19 BANK AMER CORP SUB INTERNOTES BOOK ENTRY

06050XWU3 6.000

05/15/2021 95.400

6.645 5K A

 

[txlaw]

The CDS market moves hand in hand with the bond market which is obviously huge.  BAC's credit default awaps can't widen to those levels without their corporate bonds widening to the same levels.  So it's hard/impossible to manipulate in this case.

 

I'm not sure I understand this.  I mean, I get why the CDS spread and the interest rates for the underlying credits would move in the same direction.

 

But why is it the case that the corporate bond market actually prevents CDS spreads from getting out of whack on a temporary basis?  Is it because there is some sort of rapid arbitrage going on? 

 

Does anyone who has actually traded a CDS want to chime in? 

[Kiltacular]

rogermunibond,

 

Thanks much for the info.!

[given2invest]

The CDS market moves hand in hand with the bond market which is obviously huge.  BAC's credit default awaps can't widen to those levels without their corporate bonds widening to the same levels.  So it's hard/impossible to manipulate in this case.

 

I'm not sure I understand this.  I mean, I get why the CDS spread and the interest rates for the underlying credits would move in the same direction.

 

But why is it the case that the corporate bond market actually prevents CDS spreads from getting out of whack on a temporary basis?  Is it because there is some sort of rapid arbitrage going on? 

 

Does anyone who has actually traded a CDS want to chime in?

 

Yes, you can arb it.  But I'll let someone who actually trades CDS corroborate this. 

[rjstc]

How about if BAC sells Country Wide to US government for $1. With all the debt US has it would amount to peanuts adding that in. BAC would be in good shape again. No run on bank. Stock market would boom led by BAC. US is already covering Fannie and Freddie among others so they have good experience in how to print more $ to cover. Different perspective.

[coc]

The CDS market moves hand in hand with the bond market which is obviously huge.  BAC's credit default awaps can't widen to those levels without their corporate bonds widening to the same levels.  So it's hard/impossible to manipulate in this case.

 

I'm not sure I understand this.  I mean, I get why the CDS spread and the interest rates for the underlying credits would move in the same direction.

 

But why is it the case that the corporate bond market actually prevents CDS spreads from getting out of whack on a temporary basis?  Is it because there is some sort of rapid arbitrage going on? 

 

Does anyone who has actually traded a CDS want to chime in?

 

Yes, you can arb it.  But I'll let someone who actually trades CDS corroborate this.

 

You can arb it with a basis trade. One basic example is, if the CDS protection is selling "too cheap," you buy the underlying bond and buy the CDS protection, lever it to high heaven, and collect the difference no matter what happens. (Because whether they default or not, you're made whole.) This is the "negative basis" trade - the CDS spread minus the bond spread is a negative number (you can do a positive basis trade but it's harder because you're shorting the bond). The trade is complicated even without leverage: technicalities of a "default" w/r/t the CDS paying off, interest rate exposure still exists, counterparty risk, etc...but you can do it. So there is active arbitrage that usually keeps the spreads on the bonds and on the CDS protection tight.

 

But both the price of the bond and the CDS are still set by market forces, which means anything can happen in the short run if you have forced buying or selling. For example, during the crisis, the basis blew out for junk bonds, which means if you had a leveraged position in the basis trade, you were in trouble.  Here's a good chart:

 

http://www.acredittrader.com/wp-content/uploads/2009/03/basis1.jpg

 

So yes, you can arb it, but there's no free lunch, and there are circumstances where the spreads do not move in lockstep.

[Parsad]

The fretting around Bank of America has reached absurd proportions.  Almost crazy how the frenzy is so detached from reality.  Henry Blodget, the numbskull, said today that BAC may need $100-200B!  Nuts!  Cheers!

 

http://finance.yahoo.com/news/BofA-shares-drop-debt-rb-1373949543.html;_ylt=AsO2RYspWeXraBxiih2FMQ27YWsA;_ylu=X3oDMTE1b2NpMXI1BHBvcwM2BHNlYwN0b3BTdG9yaWVzBHNsawNib2ZhbmVhcjA5bG8-?x=0&sec=topStories&pos=3&asset=&ccode=

[moore_capital54]

I feel like a kid in a candy store buying BAC under 6.20 and BCS under 10.00

 

The interview to watch today is Bove's on Bloomberg.

 

http://www.bloomberg.com/news/2011-08-23/bank-of-america-has-no-reason-whatsoever-to-increase-capital-bove-says.html

 

Not one of the 20 analysts covering BAC thinks they need any additional capital. This is not 2008.

[NormR]

While I like buying Canadian banks at nice discounts to book value, I have to arch an eyebrow at banks selling at ~1/3 book value.  They seem to have a nasty tendency to  go under. 

 

I'm sorry that I've not kept up with the BAC discussion, but what's the thesis here?  Is it a too big to fail / not enough merger partners left thing? 

 

Can someone give it to me in a nutshell?

[Parsad]

It is crazy!  This bank is trading at 0.32 times book now.  It has so much capital.  Their loan business is great.  Merrill alone would make up half the current market cap and MBNA the other half!  So is their banking business alone worth zero based on future cash flows and liabilities? 

 

I don't think so.  Their banking business now may be by far their largest asset, as the loan portfolio is cleaner and getting better every day.  Their deposit and lending business is a cash cow.  I think their management under Moynihan is terrific!  And we haven't even talked about their other subsidiaries or their $20B stake in China Construction Bank. 

 

This thing is so irrationally priced that somebody has to walk in and take a huge stake.  It won't be Buffett because of his stake in Wells, but there has to be some large institutions that would just say to themselves, let's strike a $20B preferred deal like Buffett did with Goldman and kill the shorts.  Somebody is going to buy into this thing at this price...just crazy!  Cheers! 

[moore_capital54]

Also NORM, I can't find none of the big 4 Canadian banks are trading at 1/2 book, which one are you seeing?

[NormR]

Also Norm, I can't find none of the big 4 Canadian banks are trading at 1/2 book, which one are you seeing?

 

Sorry, none at the moment, just wait, they will eventually go on sale again.  ;D

[NormR]

It is crazy!  This bank is trading at 0.32 times book now.  It has so much capital.  Their loan business is great.  Merrill alone would make up half the current market cap and MBNA the other half!  So is their banking business alone worth zero based on future cash flows and liabilities? 

 

I don't think so.  Their banking business now may be by far their largest asset, as the loan portfolio is cleaner and getting better every day.  Their deposit and lending business is a cash cow.  I think their management under Moynihan is terrific!  And we haven't even talked about their other subsidiaries or their $20B stake in China Construction Bank.

 

Thanks for the overview!

[NormR]

I feel like a kid in a candy store buying BAC under 6.20 and BCS under 10.00

 

So, which is better?  BAC or BCS?

[txlaw]

It is crazy!  This bank is trading at 0.32 times book now.  It has so much capital.  Their loan business is great.  Merrill alone would make up half the current market cap and MBNA the other half!  So is their banking business alone worth zero based on future cash flows and liabilities? 

 

I don't think so.  Their banking business now may be by far their largest asset, as the loan portfolio is cleaner and getting better every day.  Their deposit and lending business is a cash cow.  I think their management under Moynihan is terrific!  And we haven't even talked about their other subsidiaries or their $20B stake in China Construction Bank. 

 

This thing is so irrationally priced that somebody has to walk in and take a huge stake.  It won't be Buffett because of his stake in Wells, but there has to be some large institutions that would just say to themselves, let's strike a $20B preferred deal like Buffett did with Goldman and kill the shorts.  Somebody is going to buy into this thing at this price...just crazy!  Cheers!

 

Totally agree. 

 

KIC has stated that they are considering investing an additional $50 M in BAC.  I wouldn't be surprised if a syndicate of sovereign wealth funds try to push a preferred deal a la the BRK-GS deal.

 

[Munger]

will be interesting to see how this plays out...no opinion here

 

maybe someone could adress these issues instead of just responding w platitudes, which is all i've seen from the bulls

 

From CNBC

So what's going on? Henry Blodget at Business Insider sums up the "bear case" against Bank of America [bAC  6.30    -0.12  (-1.87%)  ]. The short version: a lot of people don't believe that Bank of America is correctly valuing its assets and liabilities.

 

Here are some of the things that the Bank of America observers think should or will be subtracted from the bank's $222 billion of book value:

 

$15-$20 billion in increased mortgage-litigation reserves. Zero Hedge thinks BoA is understating the liability for mortgage litigation costs by this amount. See explanation here.

 

Some percentage of $80 billion of "second mortgages." Yves Smith thinks these should probably be written down by 60%, or $48 billion.

 

You can pick your own number.

 

Some percentage of $182 billion in commercial real estate loans. The "extend and pretend" game in commercial real-estate is even more pronounced than in residential real estate. So as Yves Smith observes, there's almost no chance those loans are actually worth $182 billion.

 

A healthy percentage of $78 billion of "goodwill." Bank of America built itself by acquisition. "Goodwill" is what's left over when management overpays for something. As Yves Smith observes, Bank of America's former CEO Ken Lewis loved overpaying for things. He overpaid for Countrywide, for example, which has since been written off to zero, and Merrill Lynch, which he could have had for free by waiting a couple more days.

 

Untold amounts of exposure to collapsing European banks and sovereign debt. Yves Smith says Bank of America says its sovereign exposure is $17 billion. Really? Has the firm not written any credit default swaps protecting customers in the event that European banks or countries go belly up? Might the firm have to post some cash "collateral" to satisfy these contracts? That's what Lehman had to do, after all. And that's what made Lehman go from "having plenty of capital" to being broke overnight.

 

So, taking some back of the envelope numbers, it looks as though we could easily come up with, say, $100-$200 billion in write-offs and exposures to "clean up" Bank of America's balance sheet.