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Financial Crisis Impact on Bank of America Valuation
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Financial C i i Impac On Bank Of Ame ica Val a ion
Dec. 04, 2011 F iled under: P rint

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Did Recent Financial Crisis Negatively Affect the Worst Case Scenario Valuation for Bank of America? Our prior report on the downside risk to shares of Bank of America concluded the intrinsic value estimate under a worst-case scenario was $4.85 ("Where's the Bottom? 30% Downside Risk to Shares of Bank of
John G. Ale ander
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America from Current Levels," September 12, 2011). At that time, BAC was trading at $7.05. Since then, a significant number of macro-economic and company-specific events took place that drove BAC shares as low as $5.03, perilously close to our estimate. In this report, we review the impact GURU INTERVIEWS


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– if any – of these events on the worst-case scenario for shares of Bank of America. Challenges facing Bank of America traces its roots back to the onset of the mortgage-led financial crisis that started the middle of 2007. A weak economic outlook, persistently low interest rates, introduction of stringent regulation (including Basel III, a new global regulatory standard on bank capital adequacy and liquidity), weakness in the housing market, lingering litigation issues related to the Countrywide acquisition, and the European contagion further exacerbated the headwinds facing shares of BAC.

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In response, management has undertaken a massive strategic repositioning of the company with a focus primarily on the domestic retail market. Restructuring steps include disposal of the nonUS credit card business, exiting the mortgage wholesale channels, selling half its interest in China Construction Bank, accepting a $5 billon investment from Berkshire Hathaway, decreasing investment in its private equity segment, and continuing disposal of non-core assets. Distilling Events into Financial Impact on BAC

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VALUE IDEAS The Board of Governors of the Federal Reserve System, together with Bank of America s 3Q11 earnings results released on October 18th, serve as the most thorough and credible sources of /financial-crisis-impact-on-bank-of-america-valuation

Financial Crisis Impact on Bank of America Valuati
G. Ale ander


The worst case scenario estimate calculated in our prior report used base case assumptions of adj ed tangible book value per share of $10. According to the Federal Reserve website. if appropriate.22 at the end of the third quarter” (actually more conservative than the above calculation). mentions "tangible equity ratios and tangible book value per share of common stock are nonGAAP measures. Calculating epo ed tangible book value of equity per share. We believe the probability of BAC trading at the worst-case scenario level – on a sustained basis – is no greater than a 10 to 15%. 2011 Where's the Bottom for Bank of America Shares? 2011 TOP RANKED ARTICLES Leon Cooperman: Open Letter to President Obama guruf ocus Charlie Rose Interviews Seth Klarman .45x. Other companies may define or calculate these measures differently. Multiplying the adjusted tangible book value per share by the warranted multiple Reported Tangible Book Equit Con olida ed Financial S a emen fo Bank Holding Companie .Anh Hoang The short-sale case for K-cup owner.Anh Hoang RIMM Is a Classic "Cigar Butt" .FR Y-9C filed by Bank of Lululemon Athletica: 25 bagger retailer for 2. The form contains more schedules than any of the FR Y-9 series of reports and is the most widel requested and reviewed report at the holding company level." Bank of America s September 30. Green Mount Coffee Roaster . bank. As of June 30.45x = $4. the 2/7 . 2011. For purposes of this report. 2. Insuring management took appropriate reserves for loan losses. ALEXANDER Don't Know Delek Holdings (DK)? No Worries for N Nov 20. and finally. One of the footnotes found in Bank of America s /financial-crisis-impact-on-bank-of-america-valuation more important than having agreement on the actual per share value." As a result.85 intrinsic value estimate ($10.85) referenced earlier.57 to $13.12/5/11 Financial Crisis Impact on Bank of America Valuation information for the analysis in this report. The FR Y-9C is a primar anal tical tool used to monitor financial institutions between on-site inspections. which may include parent.matsandale MORE BY JOHN G. the end in tangible equity – and maintaining consistency in how it s calculated – is far gurufocus.75 x 0. 2011. The process for estimating Bank of America s intrinsic value comprises the following steps: 1. FR Y-9C provides the necessary data to calculate reported tangible equity per share: Chief Financial Officer Bruce Thompson stated during the 3Q11 conference call “tangible book value per common share increased $0.CanadianValu Interview with CEO of Cellceutix Corporation: Leo E Jacob Wolinsk Fundamentals of Value Creation . which produced the $4.75 and a price-to-tangible equity multiple of 0. the FR Y-9C is "used to assess and monitor the financial condition of bank holding company organizations. and nonbank entities. These sources of information prove invaluable to identifying the direct financial impact of the headline news events and management s recent actions on the intrinsic value of Bank of America shares. 3. 4.5 year consistent insider trades . the variance between the two estimates at this point isn t relevant.Rishi Gosalia America with the Board of Governors of the Federal Reserve System is the primary source for data used in the calculation of BAC s tangible book value. Adj ing the tangible book value.

“Our credit quality and delinquencies continue to improve while 3/7 .com/ /financial-crisis-impact-on-bank-of-america-valuation America quarterly conference call. This results in an Adjusted Tangible Equity per share value of $12.10. With hair-trigger investors quick to sell in event of a quarterly earnings shortfall. and Nonaccruals (less 75% of the latter two. the value of the loans that are underperforming.214 and the Shareholder's Equity account reduced by the same amount. This is not indicative of enhanced operational efficiencies but rather a change in accounting (likely a result of the disposal of other non-core. Recall that increasing the balance sheet account Allowance for Loan and Lease Losses reduces the company's reported net income and. consequently. a notable achievement. the reported tangible book equity for BAC using FR Y-9C data was $12. Loan Portfolio Review & Adjusted Tangible Equity Financial Crisis Impact on Bank of America Valuation The first step to better understanding the condition of Bank of America's balance sheet is by carefully reviewing its loan portfolio. Uninspiring Trend in BAC Nonperformance Coverage Ratio Chief Executive Officer Brian Moynihan commented in his opening remarks for the 3Q11 Bank of gurufocus. bank assets). increased a modest $8.6% sequentially.02 billion or 23% from last quarter. the book value of its shareholder s equity. Based on this analysis. closer inspection reveals a substantial portion of the improvement in tangible equity came from a reduction in the other intangible assets account. Perhaps more important than the magnitude (or lack thereof) of the increase is the fact these results reflect the first sign of gro th in Bank of America tangible equity in three quarters. which are wholly or partially guaranteed). 2011.76. One approach to independentl determining the adequacy of provisions for the Allowance for Loan Losses account is by reviewing the reported number and comparing it to the sum of Other Real Estate Owned (OREO). management s incentive not to take appropriate reserves for loan losses can be significant and must be monitored closely. on the surface. it appears the Allowance for Loan Losses account should increase $19. It appears. Total bank holding company equity. However. Bank of America s operating results improved considerably with this quarter s tangible equity per share increasing by $1. including intangible assets. down $5.12/5/11 more important than having agreement on the actual per share value.887. Loans 90+ days Past Due. The “Nonperformance Coverage ratio” (calculated below) is the Allowance for Loan Losses divided by this amount and serves as a very useful indicator of the extent to which management is adequately taking reserves for potential loan losses.1 billion or 3.31 over the prior quarter. As of June 30. and the extent to which management is properly taking reserves for loan losses.

is management is either unaware of the need for – or simply unwilling to take – the necessary reserves for these loans because of the negative impact it would have on BAC s reported quarterly earnings per share.38 billion from September 2010 to September 2011. Regardless. it appears premature to conclude credit quality are delinquencies are improving.508 in September 2011 (representing an $8.376 in September 2010 to $35. in Bank of America s tangible equity per share and the reversal of the downward trend. We based this multiple on BAC s trading history while also incorporating the price-to-tangible equity multiple at which Citigroup (C) historically traded. albeit less flattering explanation.8%. base case multiple of 0. using the calculations from the table above: Financial Crisis Impact on Bank of America Valuation Note Bank of America s Allowance for Loan Losses account – the amount determined by management – steadily dec ea ed from $43. Another potential reason is the company has employed stringent criteria for making new loans or there is a subdued demand for credit by consumers. An /financial-crisis-impact-on-bank-of-america-valuation YOU MAY ALSO LIKE Bank of America: A Capsized Shipwreck or Hidde Treasure? A Look at Bank of America Opportunity in Bank Stocks Earn Decent Returns on Your Cash While Waiting History of Bank of America s Share Dilutions 4/7 .5 billion decrease). The result is a material decline in the nonperformance coverage ratio from 71. the worst-case scenario. or non-income producing real estate from foreclosures over the same period.12/5/11 America quarterly conference call. This multiple remains unchanged with the improvement. this is partially offset by an almost 7% or $250 million increase in OREO.” It s true loans 90 days or more past due (minus 75% of those delinquent loans that are wholly or partially guaranteed) declined $1.45x tangible book value equity. The chart below shows the trend in the Nonperformance Coverage ratio over the past five quarters. particularly within the context of almost $55 billion in underperforming loans on Bank of America s balance sheet.9% to the current level of 63. over the same period. gurufocus. Price-to-Tangible Equit Multiple In November 2011 shares of Bank of America traded at.081. but not below. on an absolute basis.68 billion. while the total of nonperforming loans decreased only 67% of this amount or $5. “Our credit quality and delinquencies continue to improve while reserve coverage remains at high levels. This may reflect increased management optimism that loans made by the company will be repaid as planned and provisions for loan losses are less necessary than a year ago.581. However.

44 $12. Check O he B ffe -M nge Sc eene Wo T Ca e Scena io: In in ic Val e E ima e fo Bank of Ame ica BAC .45 = $5.S B A /financial-crisis-impact-on-bank-of-america-valuation 5/7 . ( .12/5/11 Financial Crisis Impact on Bank of America Valuation Ma ke O e al ed.45 0.T -M . 2011. 0.$5.10 N 30. Ho S S B !G F B o In e -M .45).

ca e ec i e . hi a he Wha ai ed a ec d a i ed e Sch h i g he S&P 500 eigh f a i g e i d .12/5/11 Financial Crisis Impact on Bank of America Valuation Until the downward trend in the nonperformance coverage ratio reverses and the increase in tangible book value equity proves to be more than a onetime occurrence. A e a de . P ea e i i he Ca eP i eb i e ( . The Model Portfolio of Buffett-Munger Screener has outperformed the market year-over-year. A e a de . LLC. Vi i A Screener Endorsed b Warren Buffett without Knowing In a recent interview Warren Buffett mentioned three companies that he finds attractive.85. Abo he a hor: J h G.ea ca ee a a gh Se e be 30. J h ea ed hi M. e ceed he S&P . CFA. D i g hi 12. deg ee f b i hed b i -i . D i g hi 12. please post a comment: Te t Editing Tools gurufocus. the worst-case scenario intrinsic value estimate remains unchanged at $4. deg ee f he Wha Sch deg ee f I dia a U i e i .S. Out of the three companies he mentioned.A. CFA. the kind of companies that Buffett buys and hold forever. 2011. f he U i e i f Pe a ia a d a B.c )f he J addi i a a f a d 467 b e f Va e I eb i e ( 500 a d R e 1000 Va e i dice b 532 b /financial-crisis-impact-on-bank-of-america-valuation 6/7 . It is just one of the features provided with GuruFocus Premium Membership.B. Disclosures: O e e c ie f Ca eP i I e e G . e ceed he S&P 500 a d R e 1000 Va e i e ec i e . ha e f Ba f A e ica.c ) f addi i a i f a i . Buffett-Munger Screener looks for high quality companies that are traded at fair prices. He c -a h ed "The F e f Va e I I e i g i 2000. A e a de ' Web i e Ca eP i I e e G he e he i e ea a d 98% f a 36h f i a age . About the author: J h G. P ea e i i he Ca ai . J h ea ed a a ia a d a B. hi a a i ed e dice b 711 b a d 494 b . deg ee f I i f f he U i e i eP i I dia a U i e i . e a d e a f i a a age f Ca eP i I e e i e he e he achie ed a d a age . 2011. e i g" b i hed b he J a f -i . e a i g e i d . i G ea e i a d 98% f a 36f i a agi g a h i g. He c -a h ed "The F e i g i 2000. two of them are listed in GuruFocus BuffettMunger screener. e f Pe e i g" . Click Here to Try It Free! Rate This Article: Rating: 3.ea ca ee a a e i h gh J e 30.B.A. i a agi g a e a d f i a age f achie ed a d ai ed a ec d a i g he S&P 500 eigh f a i g.S.0/5 (3 votes) e i J h G.

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