As BAC stock continues to fall, interesting perspective

[ragnarisapirate]

I can also guarantee that you and all other outside investors have ZERO insight into asset quality and the assumptions underlying the company's book value estimate.

 

I am focusing on what they are capable of earning in a "normalized" year, absent the put-back charges which will be behind them in a few years.

 

For FY13, the lowest estimate out of 10 analysts is 1.53, the highest estimate is 2.15.  "Consensus" is 1.78.

 

Do you think that is not achievable?  If so, why?

 

$1.78 would be a reasonable return on what tangible book value?  It would be exceedingly good on a $10 tangible book value, so that would be too low of a guess.  So I'd guess more than $10 based on that.

 

This is why I'm saying it's reasonable to look at the color of the paint oozing from the can -- you can look at what they currently earn TTM absent the putback costs.  But that TTM number includes some bad vintage loans that won't be around in two more years, replaced by much more profitable ones.

 

Anyways, I think a seasoned hand can make a reasonable guess on the tangible book value based on what it actually produces.

 

But it's sort of immaterial anyhow -- the value of the stock to the investor will be the returns, not the static present tangible value.  The market will likely put a 10x multiple on those returns at some point not too long after earnings normalize.  There will be nothing to be afraid of after a long period of solid vanilla lending.

 

In a market that goes irrational, what a company's liquidation value of it's tangible book means a Hell of a lot. Remember how crazy people used to go over mark to market accounting? While exactly the same as what is going on here, there are certainly similarities to draw. If they for some reason don't make it through the next few months, the normalized earnings will only matter to the company and the shareholders of the company that acquires them... Any present owners will be nearly all wiped out.

 

I don't see how anybody that isn't in the bank can calculate a margin of safety for the near term... The longer term though, is likely a different story.

 

As I have said before though, I have no position of any sort in BAC, and am frankly not knowledgeable enough to do so...

[rranjan]

Ericopoly/PlanMaestro - Have to commend on your patience. I seriously mean it.

 

Ragnarisapirate - I agree that normalized earnings are not relevent if you don't live long enough to earn.

[ERICOPOLY]

They were allowed to operate for the past 3 years, were allowed to repay TARP, and so now that loan losses are trending down they'll be in big trouble?  I sleep very well holding this one.

[Munger]

Ericopoly and PlanMaestro -- truly appreciate the dialogue and respect your viewpoints. 

 

And I agree -- if we get a normalized earnings period as analysts currently project, the stock will go a lot higher.

 

But I also agree w ragnarisapirate, which is the primary focus for me at this time.

 

The questions that are unclear to me remain 1) is tangible book value as high as management claims 2) what happens to BV if we go into a recession -- does solvency become an issue given the leverage 3) what are the ultimate put back costs 4) the risk of a Europe implosion

 

I don't know how anyone can accurately answer those questions.  And maybe I'm too risk averse but I sleep well at night.  Appears you both have positions and both have done the work to get personal conviction -- can't stress enough that I honestly hope BAC works for you...seems you have put in the effort and deserve the reward.

[ERICOPOLY]

The questions that are unclear to me remain 1) is tangible book value as high as management claims 2) what happens to BV if we go into a recession -- does solvency become an issue given the leverage 3) what are the ultimate put back costs 4) the risk of a Europe implosion

 

Here is the deal regarding my thinking.  You can own BAC or a risk free alternative.  No recession, BAC is probably a triple in 3 years.  Mild recession, maybe they struggle to meet the new stricter capital rules and have to raise some equity. Very severe recession, worst case is 100% loss.

 

So, in the benign scenario and no recession... if one stays with cash and stocks head higher from here, then one may stay with cash all throughout that period sticking to one's guns.  Kept your dollar, but lost $2 relative to the alternative outcome of getting $3 from owning BAC.

 

Given that I believe severe outcome is unlikely, I'm happier risking the $1 to get the $4 (I figure if it triples the warrants will be at least 4x current levels).  Maybe the warrants would be 5x.  I don't know.

 

I'm saying that the price of preserving $1 in the "unlikely" scenario of BAC going to zero... is that one is paying a more likely opportunity cost of $2 - $4.

 

I guess it depends on what you see as more likely. 

 

The last time home construction fell off a cliff, we had huge layoffs.  But after firing the office secretary and never bringing her back, she won't be fired again.  Whatever the next recession, it won't be quite as bad for the banks all other things being equal simply due to the fact that a lot of the easy fat has been trimmed, and the loan book is healthier given the quality of loans beginning in 2009.  Plus loan loss reserves are at much higher levels today than before 2008.  On top of that you have lower mortgage exposure.  The remaining pre-2009 loans are seasoned by a rough recession.  Probably missing many other things but there is no need to list everything.  We all know their loan book is far healthier today.

 

So anyways, I don't want to lose $3 or $4 bucks in the likely scenario.  Depends on what you think is likely I guess.  I think it's too risky to stay in cash, others disagree.  I could lose money on this, but it's money I only have in the first place due to similar opportunity cost focused choices in the past.

 

Now, if I thought the odds of success were different it would change things.  But I'm not going to say pass up an 80% chance of tripling my money simply because there's a 20% chance of losing 50%.

 

 

 

 

 

 

 

[rranjan]

Now, if I thought the odds of success were different it would change things.  But I'm not going to say pass up an 80% chance of tripling my money simply because there's a 20% chance of losing 50%.

 

Eric - You are trying to explain asymmetric risk/reward equation here which might be an irrelevent factor for some people. I guess different people have to chose their spot and live with the consequences. Be it good or bad.

[ERICOPOLY]

I also feel good on the putback front because I have a lot of MBI.  Should BAC owe them nothing, MBI gets killed and BAC soars.  Should BAC owe them 100%, MBI soars and BAC staggers.  Should BAC wind up paying MBI a fair amount, they both do well.

[Rabbitisrich]

The 3Q report will show more detail on restructured debt, which will offer more clarity on the bear argument that commercial RE lines benefit from extend and pretend. Even without the new disclosures, which we should have always had, BAC shows criticized portfolios and dollar amounts returned to performing status. So investors get a sense of magnitude and problematic areas.

 

The current bear sentiment takes a reasonable argument that bank financials don't offer full information and perverts it into the argument that no information, or insufficient information, is presented. The information is there for anyone who looks (maybe not in investment banking).

 

 

 

[ubuy2wron]

I think you do not need a credible short thesis to have a winning trade you just need to convince the mkt you have one. Financial institutions especialy highly levered ones are always vulnerable to a run. It can quite quickly snowball into a crises if investor depositors/ confidence is shaken. I believe the put back liability is a non issue BAC has many ways of dealing with this if it gets out of hand a litigated resolution would take MANY years to be resolved. BAC could alternatively just mail in the keys to Country wide to the FED, a strategic default. A run on BAC would be very difficult to engineer because of its extremely large retail deposit base. It would be fun for a co. like BAC to attack the shorts by rapidly shrinking their balance sheet and buying back debt in the mkt. place.  The opacity of BAC balance sheet is of course true for almost any large bank to say that one can presume because Mr. mkt is correct is of course relieving ones selve of doing security analysis. One does not need perfect information to make a wise investment or wager I believe right now the majority of the short side focus on BAC is very short term perhaps as little as a intra day.

[seshnath]

I think you do not need a credible short thesis to have a winning trade you just need to convince the mkt you have one. Financial institutions especialy highly levered ones are always vulnerable to a run. It can quite quickly snowball into a crises if investor depositors/ confidence is shaken. I believe the put back liability is a non issue BAC has many ways of dealing with this if it gets out of hand a litigated resolution would take MANY years to be resolved. BAC could alternatively just mail in the keys to Country wide to the FED, a strategic default. A run on BAC would be very difficult to engineer because of its extremely large retail deposit base. It would be fun for a co. like BAC to attack the shorts by rapidly shrinking their balance sheet and buying back debt in the mkt. place.  The opacity of BAC balance sheet is of course true for almost any large bank to say that one can presume because Mr. mkt is correct is of course relieving ones selve of doing security analysis. One does not need perfect information to make a wise investment or wager I believe right now the majority of the short side focus on BAC is very short term perhaps as little as a intra day.

 

Looks to me that market participants are pricing in eventual dilution of equity due to Dodd-Frank provisions on TRUPS.  BAC has about 20 billion in TRUPs that need to be redeemed or replaced by 2013.  (TRUPS lose their Tier 1 status at the end of 2013.)  Check out this briefing.

http://www.skadden.com/newsletters/Compendium_2011_011011_web.pdf

 

To me, the way to play BAC is to invest in TRUPs yielding over 10% and wait for their redemption or replacement, collecting the yield.  There are a lot of them past their redemption date inherited from all the acquisitions.  Until this particular issue is resolved, BAC equity might continue to bleed, IMHO.

 

[Uccmal]

Great thread everyone...

 

Munger, You might consider changing your moniker.  The real Munger was not particularly risk averse.  He was known for borrowing millions and pouring it into a good idea.  Now, I can appreciate that BAC is not a good idea where your concerned.

 

Al - long BAC via common and leaps now. 

 

...not the same uccmal as the idiot on the BH yahoo board

[Rabbitisrich]

 

Looks to me that market participants are pricing in eventual dilution of equity due to Dodd-Frank provisions on TRUPS.  BAC has about 20 billion in TRUPs that need to be redeemed or replaced by 2013.  (TRUPS lose their Tier 1 status at the end of 2013.)  Check out this briefing.

http://www.skadden.com/newsletters/Compendium_2011_011011_web.pdf

 

To me, the way to play BAC is to invest in TRUPs yielding over 10% and wait for their redemption or replacement, collecting the yield.  There are a lot of them past their redemption date inherited from all the acquisitions.  Until this particular issue is resolved, BAC equity might continue to bleed, IMHO.

 

Management considered the effect of Dodd-Frank on TRUPs when they forecasted Basel III compliance targets. The last earnings call and presentation covers their strategy to reduce risk weighted assets going forward, and they focus upon Tier 1 common which excludes TRUPs and treats hybrids as if they were converted to preferreds. Moynihan target 6.75-7% Tier 1 common ratio by the end of 2012 (if the world still exists...) using 2019 Basel III standards. By comparison, the required minimum ratio is 3.5%.

[Ross812]

Buffet and presumably the real Munger decided to pour 5 Billion into BAC today...

 

http://finance.yahoo.com/news/Berkshire-Hathaway-to-Invest-bw-287435668.html?x=0&.v=1

[enoch01]

What an utterly rational move by Buffett.  Not surprising at all.

[Junto]

Bronte Capital has a post up on BAC today. Definitely worth the read. http://bit.ly/qMMtvO

 

 

[Munger]

Here is the deal regarding my thinking.  You can own BAC or a risk free alternative.  No recession, BAC is probably a triple in 3 years.  Mild recession, maybe they struggle to meet the new stricter capital rules and have to raise some equity. Very severe recession, worst case is 100% loss.

 

So, in the benign scenario and no recession... if one stays with cash and stocks head higher from here, then one may stay with cash all throughout that period sticking to one's guns.  Kept your dollar, but lost $2 relative to the alternative outcome of getting $3 from owning BAC.

 

Given that I believe severe outcome is unlikely, I'm happier risking the $1 to get the $4 (I figure if it triples the warrants will be at least 4x current levels).  Maybe the warrants would be 5x.  I don't know.

 

I'm saying that the price of preserving $1 in the "unlikely" scenario of BAC going to zero... is that one is paying a more likely opportunity cost of $2 - $4.

 

I guess it depends on what you see as more likely. 

 

The last time home construction fell off a cliff, we had huge layoffs.  But after firing the office secretary and never bringing her back, she won't be fired again.  Whatever the next recession, it won't be quite as bad for the banks all other things being equal simply due to the fact that a lot of the easy fat has been trimmed, and the loan book is healthier given the quality of loans beginning in 2009.  Plus loan loss reserves are at much higher levels today than before 2008.  On top of that you have lower mortgage exposure.  The remaining pre-2009 loans are seasoned by a rough recession.  Probably missing many other things but there is no need to list everything.  We all know their loan book is far healthier today.

 

So anyways, I don't want to lose $3 or $4 bucks in the likely scenario.  Depends on what you think is likely I guess.  I think it's too risky to stay in cash, others disagree.  I could lose money on this, but it's money I only have in the first place due to similar opportunity cost focused choices in the past.

 

Now, if I thought the odds of success were different it would change things.  But I'm not going to say pass up an 80% chance of tripling my money simply because there's a 20% chance of losing 50%.

 

 

 

Congrats Ericopoly. 

 

Just to close the loop -- for me personally, I didn't view the opportunity set as singularly BAC vs cash.  Rather -- cash vs BAC vs all the other companies within my circle of competence.  And I also don't view the opportunity set as fixed at a point in time.  So if BAC goes higher, I miss the return but I prefer to hold for cash for a better risk/reward within my circle of competence that will unquestionably emerge in the future.

 

Question for you and others -- if you believed that BAC was a 4-5 bagger on stand alone basis, do you now put every single $ you have into BAC and more via margin?  Or does the raise of expensive capital lead you to question whether BAC was as sound as you originally believed?  Remember -- GE's stock has been a terrible investment (especially relative to the market) since Buffett's pfd/warrant deal and GS stock has really done nothing as well, although it did move higher before coming all the way back down. 

 

 

[finetrader]

Question for you and others -- if you believed that BAC was a 4-5 bagger on stand alone basis, do you now put every single $ you have into BAC and more via margin?

 

You're right it is not too late too invest in it if you have a long term horizon.

I'll let the dust settle after this news and will buy more. This Buffett investment convince me now more than ever that this is an opportunity too make a lot of dough in a 5 years horizon (perhaps sooner) when us real estate will pick up.

[Uccmal]

Munger,

 

I beg to differ on whether or not GE was a terrible investment after Buffett bought those preferreds.  I bought Leaps on GE at under $10 and it was one of my greatest hits.  I still buy LEaps from time to time on Ge when it drops below a certain price and reduce above a certain price.  Small part of overall portfolio but very lucrative.  To your statement I would not invest in GE common as the maximum return is probably under 50% from here in the next couple of years.

 

I have held BAC for months in various forms and it will now be another greatest hit.  The wildest part is the actual percent of my portfolio is so low at this point. 

[Munger]

Uccmal -- I'm just asking re a LT investment in the common.  Congrats re the leaps -- nice work.

[txlaw]

Question for you and others -- if you believed that BAC was a 4-5 bagger on stand alone basis, do you now put every single $ you have into BAC and more via margin? 

 

This is a dumb and unnecessarily provocative question, Munger, and you know it.

 

Or does the raise of expensive capital lead you to question whether BAC was as sound as you originally believed?

 

Nope.  Capital raise from WEB fits very well with my BAC thesis. 

 

Remember -- GE's stock has been a terrible investment (especially relative to the market) since Buffett's pfd/warrant deal and GS stock has really done nothing as well, although it did move higher before coming all the way back down.

 

Ah . . . see, this is one of the reasons, among others, why you're getting such negative feedback from the board.  This statement right here is antithetical to the value investor's mentality.  You're assuming that the market is correct about GE and GS, and that the investment was terrible because the prices of GE and GS have gone down. 

 

The real Munger would never say such a thing.

[rranjan]

 

Ah . . . see, this is one of the reasons, among others, why you're getting such negative feedback from the board.  This statement right here is antithetical to the value investor's mentality.  You're assuming that the market is correct about GE and GS, and that the investment was terrible because the prices of GE and GS have gone down. 

 

The real Munger would never say such a thing.

 

TxLaw - BAC might or might not turn out to be a good investment but I have seen many people pretending to be a value investor but you can generally catch them quickly due to passing some silly statements( like judging the investment merit on short term price movements). It's another thing to not have an opinion or different opinion but if anyone talks about the merit of an investment based on stock price being temporarily being up or down in many threads then you do get a decent idea about how a person thinks.

 

 

[txlaw]

 

Ah . . . see, this is one of the reasons, among others, why you're getting such negative feedback from the board.  This statement right here is antithetical to the value investor's mentality.  You're assuming that the market is correct about GE and GS, and that the investment was terrible because the prices of GE and GS have gone down. 

 

The real Munger would never say such a thing.

 

TxLaw - BAC might or might not turned out to be a good investment but I have seen many people pretending to be a value investor but you can generally catch them quickly due to passing some silly statements( like judging the investment merit on short term price movements). It's another thing to not have an opinion or different opinion but if anyone talks about the merit of an investment based on stock price being temporarily being up or down in many threads then you do get a decent idea about how a person thinks.

 

I just hate that his handle is "Munger." 

[rranjan]

I just hate that his handle is "Munger."

 

Funny because I was thinking if it's possible to stop people using handle such as Buffet or Munger ot Graham if they are poles apart in thinking. Handle might create an association bias and people might take time to respond which they would have ignored in general. But I guess it's an online forum and people can chose any handle they want.

[given2invest]

I just hate that his handle is "Munger."

 

Funny because I was thinking if it's possible to stop people using handle such as Buffet or Munger ot Graham if they are poles apart in thinking. Handle might create an association bias and people might take time to respond which they would have ignored in general. But I guess it's an online forum and people can chose any handle they want.

 

Are you 12?

[Liberty]

I just hate that his handle is "Munger."

 

Funny because I was thinking if it's possible to stop people using handle such as Buffet or Munger ot Graham if they are poles apart in thinking. Handle might create an association bias and people might take time to respond which they would have ignored in general. But I guess it's an online forum and people can chose any handle they want.

 

Are you 12?

 

This is standard cognitive science. Names mean something, and our brains can't help but make associations.

 

Or maybe I should just change my handle to 'Warren Buffett'..