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Bank of America

December 10, 2012 Alex Bossert

Alex Bossert Summary:

Bank of America

Bank of America is a strong, wellled company...I am impressed with the profitgenerating abilities of this franchise, and that they are acting aggressively to put their challenges behind them. - Warren Buffett August 25, 2011 Bank of America was on the brink of Bankruptcy just a few years ago. Under prior management, growth in assets was pursued at the expense of sounds business practices. This combined with years of poor underwriting and the disastrous loans that came with the acquisitions of Countrywide Financial and Merrill Lynch, caused huge damage to the franchise. To this day Bank of America remains one of the most shorted stocks on the NYSE. However, the problems BAC has faced are temporary. Brian Moynihan became CEO in 2010 and has made it a priority create a fortress balance sheet and clean up their legacy issues. The underlying business is very high quality and is producing 13-15% ROTE. The high earnings power of the underlying business is being clouded by a very high expense rate, high litigation costs, mortgage put backs, high cost long term debt, etc. These issues are quickly being resolved. I expect by 2014-2015, Bank of America will be mostly finished taking care of the financial crisis related issues. Bank of America is currently one of the best capitalized banks in the United States. Their capital levels are already in excess of the Basel 3 requirements that come into full effect in 2019. Basel 3 requires them to be at a tier one common equity ratio of 8.5% by 2019. At the end of the 3rd quarter they were already at 8.97%. At todays price ($10) Bank of America is selling at one of the widest discounts to its tangible book value ($13.50) in its history. By 2015, I expect BAC to be earning in excess of $30 billion/ year pre-tax and potentially well in excess of this. At this level of earnings, Bank of America is worth at least $25 per share. In addition, in 2013 alone Bank of America could return up to $18 billion to shareholders based on Brian Moynihans statement during the 3rd quarter conference call where he indicated that nearly all capital going forward will be returned to shareholders.

Business: Bank of America Corporation provides a diversified range of banking and nonbanking financial services and products through six business segments: Deposits, Global Card Services, Home Loans & Insurance, Global Commercial Banking, Global Banking & Markets (GBAM) and Global Wealth & Investment Management (GWIM), with the remaining operations recorded in All Other. At September 30, 2010, the Company had $2.3 trillion in assets and approximately 272,600 fulltime equivalent employees. On January 1, 2009, the Company acquired Merrill Lynch & Co., Inc. and as a result, has one of the largest wealth management businesses in the world with over 16,700 financial and wealth advisors, an additional 3,000 clientfacing professionals and more than $2.1 trillion in net client assets. Additionally, BAC is a global leader

Alex Bossert

Bank of America

in corporate and investment banking and trading across a broad range of asset classes serving corporations, governments, institutions and individuals around the world. As of September 30, 2010, BAC operates in all 50 states, the District of Columbia and more than 40 foreign countries. The Companys retail banking footprint covers approximately 80 percent of the U.S. population and in the U.S., serves approximately 57 million consumer and small business relationships with 5,700 banking centers, 17,750 ATMs, nationwide call centers, and leading online and mobile banking platforms. Normalized Earnings: Expenses Are Far Above Normal BAC expects to achieve an annualized cost savings target of $5 billion annually by Q3 2013 in its consumer businesses excluding LAS. This initiative is called NewBAC 1. In addition, by mid-2015 they expect to reduce expenses at corporate, institutional and wealth management businesses by $3 billion annually called NewBAC 2. Separately, BAC is currently spending $1 billion per quarter on legal expenses. To put this all together, they are already part way through NewBAC Phase 1 and saving about $1 billion a year. They said part 1 will be completely in place by Q3 2013 saving an additional $4 billion per year. When it comes to legal expenses of $1 billion per quarter this comes down with every lawsuit that is runoff. Then comes NewBAC phase 2 which will be finished by mid 2015 which is $3 billion in annual cost savings. In 2014, cost savings should be at least $5 billion annually. In 2015 costs will be lower by around $8 billion per year. Neither of these numbers include reduced legal expenses. I expect this could be reduced to $250 million per quarter, a reduction of $3 billion per year. High Cost Debt Has Built Up From Prior Overpriced Acquisitions And Is Being Repaid CFO Bruce Thompson said at the September Barclays Financial Services Conference, the greatest opportunity to reduce funding costs is continued reduction in long term debt as this expense is approximately 5x the cost of deposits and long term debt is one third the amount of deposit funding. Long term debt has been reduced from $479 billion in Q3 2010 to $287 billion in Q3 2012. In the third quarter they had $2.24 billion in interest expense from their $287 billion in long term debt and only $.48 billion in expense from over $1 trillion in deposits. They save about $1 billion/ year in interest per $30 billion of long term debt paid off. They can pay back about $30 billion in debt per year. The Net Interest Margin Is At A Very Depressed Level: In the 3rd quarter Bank of Americas net interest margin was 2.35% compared to 3.66% at Wells Fargo. If Bank Of America reached Wells Fargos net interest margin that would result in $23 billion more in revenue per year. This is not likely and doesnt factor into my normalized

Alex Bossert

Bank of America

revenue and earnings calculation. Part of the reason for Bank of Americas depressed net interest margin is because they have nearly a million of 60+ day delinquencies on the books. Delinquencies Are Tying Up Capital That Could Be Employed Elsewhere And Is Costing The Company A Substantial Amount In Expenses: In the third quarter they're showing 936,000 60+ day delinquencies and that's costing them $3 billion per quarter or $12 billion per year. I expect a normalized figure is 300,000 delinquencies that will cost them $500 million per quarter, or $2 billion year. Both the number of delinquencies are elevated and the servicing cost per customer. BAC has a significant amount of dead weight capital that when cleaned up will be a significant driver of earnings. The Company Is Quickly Running Off the High Delinquencies, Litigation And Expenses In The Legacy Asset Servicing Division In the Legacy Asset Servicing division 3Q12 expenses were $3.4 billion. Excluding the litigation portion of this expense, over the past 4 quarters LAS non-interest expense was $10.4 billion. Management has said they expect this to come down to $300 million per quarter or $1.2 billion per year. The non litigation noninterest expense will decline by about $8 billion per year. In the Q3 conference call Bruce Thompson said this should be complete by the end of 2013 and into the beginning of 2014. In addition, there is $2.4 billion in yearly litigation cost in this division. Id assume this will fall in proportion with the reduced delinquencies. 3rd Quarter Earnings: Pre-tax earnings for quarter after preferred stock dividends were $737 million. Special items include a charge of $1.9 billion for FVO and DVA, in addition there was a $800 million charge for the reduction in UK tax rates. 3Q12 Summary Income Statement Net Revenue FVO and DVA adj add back Total Revenue non interest expense Pre tax pre provision earnings provision for credit losses income before income taxes $20.60 $1.90 $22.50 $17.50 $5.00 $1.80 $3.20

Alex Bossert

Bank of America

What Will Future Normalized Earnings Look Like Estimated 2013 Results: Earnings should come in at around $1 based on analyst expectations. In addition, a significant amount of capital could be returned to shareholders. Next years earnings plus the earnings from the 4th quarter will allow BAC to return up to $18 billion to shareholders. Even though the financial statements show a large amount of tax, due to DTAs BAC is growing capital at 1.5x net income. BAC has a tier 1 common equity ratio of 8.97% and has blown through the Basel 3 Tier 1 ratio requirement of 8.5% by 2019. Moynihan said after BAC reaches 9%, capital will be returned to shareholders on roughly a 1/3 for buybacks, 1/3 to dividends and 1/3 to grow the business (source November 13th presentation). Estimated 2014 Results: Pre-tax earnings will grow significantly from a base of around $13.5 billion in 2013. In 2014 many of the initiatives aimed at reducing costs will be in place. BAC at this point will be saving at least $10 billion per year from LAS, $5 billion from NewBAC1, $3 billion from reduced legal expenses including LAS legal expense and $2 billion from retiring long term debt and replacing it with deposits. At this point pre-tax earnings are $33.5 billion. In addition, the net interest margin is very depressed due to low interest rates. A small increase in the NIM could boost income by a significant amount. A stronger economy would also be a big boost to BAC. Estimated 2015 Results: In 2015, the majority of the litigation, representation and warranties expenses and other overhang from the financial crisis will be over. NewBAC 2 will save an additional $2 billion, litigation should fall by an additional $1 billion, and $1 billion in long term debt savings. This will bring pre-tax earnings to $37.5 billion. Brian Moynihan said at the Citi Financial Services Conference on march 8 2012 that pre-tax earnings in a normal environment will be $35-40 billion per year. Moynihan has a history of under promising and over delivering. For example, in April 2012 he stated his year end goal was to reach a Tier 1 Basel 3 common capital ratio of 7.5%. At the end of the third quarter the company is already at 8.97%. Historically large money center banks have earned on average between .75-1.5% after tax earnings as a percent of assets. Given the increase capital ratios required going forward, I expect Bank of America to come in at the lower end of that range at around 1% once they have cleaned up the current mess. This would result in pre-tax earnings in excess of $30 billion per year.

Alex Bossert

Bank of America

Return of Capital to Shareholders is Likely: As of the end of Q3 BAC had a Basel 3 Tier 1 common capital ratio of 8.97%. Under Basel 3 they are required to have a Tier 1 common capital ratio of 8.5% by 2019. They are already in excess of this requirement. CEO Brian Moynihan has said that once BAC is better capitalized he plans to pursue no acquisitions and return capital to shareholders. During the 3rd quarter conference call Moynihan indicated his intention to return near 100% of capital earned going forward. They will generate all the capital they need to run the business from loans in run off.

Future Claims: Warranties and Representations Liability: BAC has a $16.3 billion reserve for losses and has already paid out around $13 billion. In the 3rd quarter conference call CFO Bruce Thompson said, We currently estimate that the range of possible loss for both the GSEs and non GSEs for the representation and warranties exposure could be up to $6 billion over our accruals of September 30th. Monolines: At September 30th 2012 total monoline claims were $2.6 billion with two monoline insurers. The loss rate with the monlines has been higher than other categories and the courts have been favoring the monolines. This category is not a big concern given that its small compared to the other claims categories.

Conclusion: Bank of America was on the edge of bankruptcy just a few years ago. Since new management led by Brian Moynihan took over in 2010, management has been working quickly to clean up the balance sheet and generate strong earnings. Today the bank is generating very little earnings power. However, in just a few years time this will change as expenses are cut, litigation runs off, mortgage put backs decline, the net interest margin returns to normal, and long term debt is replaced by deposits. I expect Bank of America to reach at least $30 billion in normalized earnings by 2015. The stock is worth around $25 per share or 2x book value. In addition, Bank of America has already completed raising all necessary capital to meet Basel 3 requirements. Even though they are not required to do so until 2019. This sets the stage for significant returns of capital to shareholders. I expect management to begin returning capital to shareholders in 2013.

Alex Bossert

Bank of America

Appendix: A) Sources 1) Bank of America Merrill Lynch Banking and Financial Services Conference Presentation (Nov 13th 2012): Webcast: http://www.veracast.com/baml/banking2012/main/player.cfm?eventName=1011_bankofa Slides: http://phx.corporateir.net/External.File?item=UGFyZW50SUQ9NDg1NjkxfENoaWxkSUQ9NTIxMTgwfFR 5cGU9MQ==&t=1 2) ValueXVail 2012 (June 2012) Kai Shah Bank of America Presentation: http://www.scribd.com/doc/98208590/ValueXVail-2012-Kai-Shih 3) Third Quarter Earnings Release: http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irolnewsArticle&ID=1746326&highlight=#fbid=eHGELDajqMT 4) 3rd Quarter Conference Call Presentation: http://phx.corporateir.net/External.File?item=UGFyZW50SUQ9NDgyMzMyfENoaWxkSUQ9NTE2ODI1fF R5cGU9MQ==&t=1 5) 3rd Quarter Earnings Supplemental: http://phx.corporateir.net/External.File?item=UGFyZW50SUQ9MTU3MjEzfENoaWxkSUQ9LTF8VHlwZT 0z&t=1 6) 2nd Quarter 10Q http://services.corporateir.net/SEC/Document.Service?id=P3VybD1odHRwOi8vaXIuaW50Lndlc3RsYXdidXNp bmVzcy5jb20vZG9jdW1lbnQvdjEvMDAwMDA3MDg1OC0xMi0wMDAzNjIvZG9jL0 JhbmtvZkFtZXJpY2FDb3Jwb3JhdGlvbl8xMFFfMjAxMjExMDIucGRmJnR5cGU9MiZ mbj1CYW5rb2ZBbWVyaWNhQ29ycG9yYXRpb25fMTBRXzIwMTIxMTAyLnBkZg= = 7) Special Conference Call With Fairholme Funds August 2011: http://seekingalpha.com/article/286691-bank-of-america-corporation-special-call 8) Goldman Sachs Financial Services Presentation December 4th 2012: http://phx.corporateir.net/External.File?item=UGFyZW50SUQ9MTYzODg4fENoaWxkSUQ9LTF8VHlwZ T0z&t=1 9) Brian Moynihan on CNBC December 4th 2012:
http://video.cnbc.com/gallery/?play=1&video=3000133184 http://video.cnbc.com/gallery/?play=1&video=3000133188 http://video.cnbc.com/gallery/?play=1&video=3000133187 http://video.cnbc.com/gallery/?play=1&video=3000133185

10) Dumb and Dumber: The Debt Valuation Adjustment Mess We're in Today: http://www.minyanville.com/trading-and-investing/earnings/articles/DVA-debtvaluation-adjustment-morgan-stanley/4/19/2012/id/40511

Alex Bossert

Bank of America

11) Americas Best Capitalized Banks: http://wallstcheatsheet.com/stocks/and-the-bestcapitalized-bank-is.html/ 12) Analysts Discussing Bank Of America October 17th: http://www.bloomberg.com/video/bank-of-america-profit-litigation-costsax3KLVBbRzexrc7QQLcMYg.html 13) Meredith Whitney October 24th on CNBC: http://video.cnbc.com/gallery/?video=3000124253&play=1 14) Third Quarter Conference Call: http://seekingalpha.com/article/930181-bank-of-americas-ceo-discusses-q3-2012-results-earnings-call-transcript?part=single 15) BAC Management Sees $40 Billion in Normalized Earnings: http://www.thestreet.com/story/11756844/1/bank-of-america-sees-40b-normalizedprofits.html?puc=yahoo&cm_ven=YAHOO 16) Corner Of Berkshire And Fairfax Board, BAC Thread: http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/bac-wt-bank-ofamerica-warrants/ 17) BAC Wins Limitations on Countrywide Loans: http://www.bloomberg.com/news/201211-26/bofa-wins-on-standing-of-countrywide-securities-investors.html?cmpid=yhoo 18) BAC Analysts Discuss BAC On Bloomberg: http://www.bloomberg.com/video/why-buythe-whole-basket-when-you-can-buy-the-best9hkKeDoXSWamwDRIcad4ng.html?cmpid=yhoo 19) U.S. judge says FHFA cases against banks can proceed: http://finance.yahoo.com/news/u-judge-says-fhfa-cases-220343898.html 20) BAC Analysts on Litigation Costs and Future Profit: http://www.bloomberg.com/video/bank-of-america-profit-litigation-costsax3KLVBbRzexrc7QQLcMYg.html 21) Brian Moynihan Declares Victory Over Capital Doubters: http://www.bloomberg.com/news/2012-10-23/bofa-ceo-moynihan-declares-victory-overcapital-doubters.html 22) Bank of America Corporation at BancAnalysts Association of Boston Conference Friday, November 2, 2012: Webcast: http://investor.bankofamerica.com/phoenix.zhtml?p=iroleventDetails&c=71595&eventID=4859159#fbid=eHGELDajqMT Presentation: http://phx.corporateir.net/External.File?item=UGFyZW50SUQ9MTYwMjM4fENoaWxkSUQ9LTF8VHlwZ T0z&t=1 23) Bank of America 2011 10-K: http://services.corporateir.net/SEC/Document.Service?id=P3VybD1odHRwOi8vaXIuaW50Lndlc3RsYXdidXNp bmVzcy5jb20vZG9jdW1lbnQvdjEvMDAwMTM3MDIzOC0xMi0wMDAwMTMvZG9j L0JhbmtvZkFtZXJpY2FDb3Jwb3JhdGlvbl8xMEtfMjAxMjA5MjgucGRmJnR5cGU9Mi Zmbj1CYW5rb2ZBbWVyaWNhQ29ycG9yYXRpb25fMTBLXzIwMTIwOTI4LnBkZg= = 24) SumZero Write Ups: http://www.sumzero.com/pro/research/3528 http://www.sumzero.com/pro/research/2205 http://www.sumzero.com/pro/research/1362 http://www.sumzero.com/pro/research/1185

Alex Bossert

Bank of America

http://www.sumzero.com/pro/research/862 25) Value Investors Club Write Ups: http://valueinvestorsclub.com/value2/Idea/ViewIdea/60745 http://valueinvestorsclub.com/value2/Idea/ViewIdea/58480 http://valueinvestorsclub.com/value2/Idea/ViewIdea/53693 26) Bank of America 3rd Quarter Earnings Conference Call Transcript: http://seekingalpha.com/article/930181-bank-of-america-s-ceo-discusses-q3-2012results-earnings-call-transcript 27) Fairholme Fund Report On BAC: http://www.fairholmefunds.com/sites/default/files/120820%20%20Case%20Study%20I%20%28With%20Disclaimers%29.pdf 28) Derivatives Risk Part 1: http://seekingalpha.com/article/312845-bank-of-americapiercing-its-opaque-balance-sheet Part 2: http://seekingalpha.com/article/315528-bank-of-america-piercing-its-opaquebalance-sheet-part-ii 29) Deal To Settle MBIA Claim Is Likely Early Next Year: http://www.nytimes.com/reuters/2012/12/12/business/12reuters-bankofamericambia.html?hp&_r=0 30) http://www.bloomberg.com/news/2012-12-12/bofa-seeks-to-knock-out-mbia-claims-tiedto-countrywide.html 31) Analysis of Bank Of Americas Balance Sheet: http://seekingalpha.com/article/312845bank-of-america-piercing-its-opaque-balance-sheet 32) WSJ Statutes Of Limitations: http://professional.wsj.com/article/SB10001424053111903927204576570951393585760. html?mg=reno64-wsj 33) Bank of America Delinquent Loans Mean Losses: Mortgages http://www.bloomberg.com/news/2012-12-19/bank-of-america-delinquent-loans-meanlosses-mortgages.html