Price around $5.4/share.

The company
Bank of America is probably the purest reflection of the United States economy of any of the largest financial institutions. The bank operates in all 50 states and more than 40 non-US countries. It owns or services 1/5th of all home loans in the U.S., serves 58 million customers with more than 5,700 retail branches and has 18,000 ATMs.

Business Segments: Current %age of TR, q3-11.

Deposits Card Services Consumer Real Estate Services Global Commercial Banking Global Banking & Markets Global Wealth & Investment Management All Other 14% 20% -9% 12% 29% 19% 16%

Management
CEO Brian T Moynihan: Born 1959. Graduation Brown University. Joined Fleet Boston in 1993. After the BAC/FB merger in 2004, he served as president of Global Wealth & Investment management. CEO of Merryl Lynch after the merger Sept. 2008. CEO of BAC Dec. 2009.

Ownership: 10,464,395 (diluted common issued and outstanding)

Company BAC WFC GS MS JPM Insider % 0.02% 0.00% 0.02% 22.63% 0.13% Inst. % 58.03 77.43 75.38 61.27 74.53 Nr Shares 81.907 77.600 13.382 7.053 6.195 % of Company 0.78% 0.74% 0.13% 0.067% 0.059% % of Portfolio 6.81% 1.40% 2.43% 16.73% 2.64%

Funds Fairholme Dodge & Cox Thornburg Value Pabrai Inv. Oakmark Select

Warren Buffet & BAC

Past During the subprime crisis in 2007, BRK bought 8.7 million shares, quickly increasing the stake to 9.1 million shares. Buffett was critical of management at the time. He told Financial Crisis Inquiry Commission that Bank of America paid a crazy price to acquire Merrill Lynch in the midst of the disaster. BRK sold off its remaining shares in Bank of America at the end of 2010. The Buffett Put In August 2011, BRK lent 5B to BAC at 6% interest. Moreover, received a warrant to buy 700m shares at 7.14 each, good for 10 years. BAC can buy back the preferred at any time for a 5% premium. This seems to be a good deal for BRK, less for BAC shareholders. It seems to be a bet, not an investment. As long as the bank remains solvent, BRK gets to clip the coupons and, will get a big windfall gain if the bank recovers. The preferred shares are unsecured, meaning that the bet demonstrates a belief that BAC will stay solvent over the next five years. Why did BAC borrow money from BRK? According to Basel III, banks need to gradually deduct deferred tax assets (DTAs) from their common equity Tier 1. Meaning, the increase in DTAs disallowed (primarily due to the expiration of the longer lookforward period granted by the regulators at the time of the Merrill Lynch acquisition and an increase in net deferred tax assets due to pretax results.) was partially offset by the warrant issued in connection with BRK. Moreover, the transaction also reduced the risk-weighted assets. The end result, BAC both improves the denominator and numerator in the core Tier 1 ratio and, received a vote of confidence. WB Quotes on BAC: I am impressed with the profit-generating abilities of this franchise, and that they are acting aggressively to put their challenges behind them. Bank of America is focused on their customers and on serving them well. Thats what customers want, and thats the companys strategy. WB aug-11 The bank has a wonderful underlying business its got lots of problems,The bet is, is Brian going to get rid of those problems?It wont take six months or a year; it will take much longer than that even. But the underlying business is doing fine. WB sept-11 ...I expected him to clean up a lot of the problems from the past, and they're going to take a long time to clean up.I mean, two years from now and three years from now you'll still see some headlines on itNo, it's a great underlying business. It's a fabulous underlying business, but it's got a lot of problems from the past. Brian didn't create those, he has to he has to clean up the mess. But I've been in those kinds of situations before. WB sept-11

Well, he's had a dynamic problem. I know when I went into Solomon, I found out a lot of things in the third month I didn't know in the first month. And when you have problems to clean up, when American Express had problems in the 1960s to clean up, when GEICO had problems in the 1970s to clean up, when Solomon had problems in the 1990s to clean up, usually the problems are bigger and more longer-lasting than you think, but they also are solvable. And it takes time, it takes a lot of effort, it takesit takes a lot of grief, you know. But if you have a wonderful underlying business, which the B of A does, which GEICO did, which American Express did, you know, you'll get them resolved. WB nov-11 The common vs. the preferred, No, I'm a shareholderI'm a shareholder. The shareholders got wiped out at WaMu, Wakovia, Freddie, Fannie, almost at Citi, almost at AIG, going down the line, I mean theso as a shareholder I'm not protected. WB nov-11 Well, I would say this, when Iwhen we buy our BofA preferred, we do not expect the government ever to pay off our preferred. We do expect the government to pay off depositors. WB nov-11 Yeah, but I'm buying a different share in several ways, though, too, than she buys in that I was buying something for $5 billion, where we had nowhere we contractually we're not allowed to resell it for five years. So in the sense, we were putting money in where we couldn't change our mind next week or hope that it bounced up or anything like that. We were putting money in saying that in five years, we think this is plenty good. And that is a real vote of confidence. I mean, it's not a vote of confidence to go out and buy, you know, to buy 100 shares of XYZ and sell it the next day. But when you put $5 billion in and you can't take it out, you can't touch it for five years; I think that is a valid vote of confidence. It doesn't mean that the common is a buy or a sell or a hold or, you know, anything else, but it does mean that we felt very strongly that the B of A was going to do get rid of its legacy problems over time and it'll take plenty of time and that the underlying deposit franchise and business they have is a terrific business. WB nov-11

Economic Moat
Apart from size, reach and footprint, its difficult to see strong competitive advantages in BAC. Banks products/services today could be compared to a commodity type product where the actual product virtually does not differentiate much from other products in same industry. Despite huge commercial costs, these companies will find it very hard to make any meaningful differentiation of their products. Therefore, commodity type comps are primus candidates for problems. Since their product fundamentally does not differ from other products; the only competitive advantage will be through price action, which in turn affects margins. The one time financial companies are doing well, is during cycles of high demand of credit, which is very hard to predict. The bottom line: Because bank services can be compared to commodity type products, the long-term performance will, on most part, be based on the quality of management. Managers control the two most critical variables: Costs and Loans. Bad managers drives up costs and builds up a bad loan stock, while good managers finds ways to cut costs and seldom issues bad loans. Moynihan seems to fit into the category of a good manager due to a) reducing costs by an expense reduction program New BAC (first phase cutting 30,000 jobs) b) bringing the bank back to its core business c) selling extraneous assets to raise capital d) bringing down liabilities; non-performing loans in both consumer and commercial sector.

Financial Data
Since book value is an accounting concept, telling you what has been put in, I will try to determine how much the book (CET1) might fall in value and then estimate a return on that equity that could be generated in order to get a proxy for cash flow -- a proxy for the intrinsic value.

-The Risk
Can BAC stay solvent according to Basel III?

Basel III -- BIS define Common Equity Tier 1 (CET1) as:

Common shares, retained earnings, accumulated other comprehensive income and other disclosed reserves. Phase-in of deductions from CET1 including amounts exceeding the limit for a) Deferred tax assets b) mortgage service rights and, c) significant investments in the common shares of unconsolidated financial institutions. On 1 January 2013, a bank must deduct the amount by which the aggregate of the three items above exceeds 15% of its common equity component of Tier 1. *The minimum CET1 capital needs to be 4.5% as of 1 Jan.2013

CET1 in BAC balance sheet.

Oversimplified Quick Test -- can they pass the 4.5% CET1 as of 1 Jan.2013 According to Q3-11, BAC states that Tier 1 common capital is USD 117.6Bn and, the riskweighted assets (RWA) is stated to be USD 1.360Bn, bringing the CET1 ratio to 8.65%. We cant really know the denominator or the numerator, so lets put things into perspective and play around a bit with the numbers. If we increase the denominator (RWA) with 50% to 2000bn, and lower the numerator with 30%, to 80bn, the ratio would come down to 4%. The recent sale of CCB adds 3.5bn, if BAC can generate an additional 1.3bn per quarter through internal generation, they would reach the 4.5% barrier. Adjusting the CET1 value to worst case scenario; (idea from a case study in gurufocus) BAC has stated that it aims to reach a goal of CET1 of 6 % by the end of 2012. Using a conservative and realistic number, increasing the RWA with 32% brings us to 1800bn. We can then back in the numerator at 121bn. Since we cant really now the numerator (CET1), we want to figure out the effect if management is proved to be overly optimistic? Every quarter, BAC adjusts its Allowance for loan and lease losses and according to q3-11, the amount declined to 35.082bn from the previous 37.312bn in q2-11. That 35.085bn is what BAC calculate would cover non-performing loans (stated as 21.039bn in q3-11) which brings the coverage ratio to 167%. A loan becomes a non-performing loan when interest and principal are past due 90 days and more, so what we really want to know is how a write-down in non-performing loans would effect to the CET1.

According to Federal Financial Institutions Examination Council: Oreo, Past due 90 days and more and, Nonaccrual loans of BAC is structured as following: USD Billions Other Real Estate Owned Past Due 90 days and more Nonaccrual Loans Sum

4.045 40.5571 31.5951 76.1972

Under schedule HC-N, line 11 it states: Loans and leases reported in items 1 through 8 above which are wholly or partially guaranteed by the U.S. Government (excluding loans and leases covered by loss-sharing agreements with the FDIC) If we credit the wholly or partially guaranteed portion amount with 25% to past due 90 days and nonaccrual, we get the following: a) First Scenario USD Billions Other Real Estate Owned Past Due 90 days and more Nonaccrual Sum Credit Losses Allowance for credit losses Difference

4.045 33.512 31.462 69.020 69.020 35.082 (33.938)

Reducing the CET1 (core shareholder equity) with 33.938bn results in: 83.720bn in shareholder equity $8/Share P/B 0.68x. b) Second Scenario Let us assume that the wholly or partially guaranteed portion is not being committed and Oreo, past due 90 days and nonaccrual posts gets written down to zero, giving the following result: 76.543bn in core shareholder equity (sum credit losses 76.197bn allowance of 35.082bn = difference of -41.115bn. Stated CET1 117.658-41.115 = 76.543bn) $7.31/Share P/B 0.74x

Taking the second scenario, assuming 76.543bn as numerator and RWA of 1800 as denominator in Core Tier 1 Ratio, we end up with a 4.25% Core Tier 1 Ratio. Not sufficient to achieve the goal of 6 but enough to stay solvent with the recent sale of CCB and BlackRock which brings the ratio up to 4.5%... everything else staying equal. But at the same time, the leverage ratio would be around 30:1 making it a very, very dangerous investment, or maybe it would be more proper to say a dangerous speculation. According to Basel III criteria, BAC should be able to stay solvent without issuing new equity.

Exposure to Europe The total sovereign exposure to Europe is 1.730bn (based on selected countries). Taking this nr to stated CET1 equals approximately 1.45% of capital funds. Non-sovereign liabilities amount to 12.904bn, which equals around 11% of capital funds. Total exposure (excluding CDS protection) amount to 12.45%. Even is Europe breaks apart, BACs would still meet Basel III criteria. BAC does not state the exposure to France and Germany, only that the cross-border exposure in Japan and France is 21.1bn and 17.1bn respectively.

Financial Data
-The Reward
Today, we believe to be at a similar tipping point for financials with enormous cash flows and diminishing restructuring expenses for the illogical extremes of 2006/2007. Their preprovision, pre-tax earnings power is compelling. A not unreasonable 1% return on Citi's assets or 10% return on equity would yield $6 per share. A 1% ROA or 10% ROE for BofA (BAC) would yield over $2 per share. Bruce Berkowitz q2 letter-11 Looking only at historical facts, the above statements seem valid.

Return on Avg. Total Assets, % (Income After Tax), FY

1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 -0.2 -91 -92 -93 -94 -95 -96 -97 -98 -99 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 -11

The Average Return on Total Assets from period 1991-2011 is 1.02%. BAC is currently turning over their total assets 0,037 times indicating a profit margin over 25% (0.0102/0,037). But BAC has increased their total asset base the last five years with a compounded annual rate of 11% which should mathematically make it a lot harder for them to achieve a 1% return on assets in the future. Even before the crisis, that previous ROA should have been computed down to maybe 0.9% to reflect reality. So, it is not illogical to presume cautiousness and compute it downwards even more to create MoS to i.e. percent calculated on the recent growth in asset base. Dividing percent with total asset turnover (using CET1) results in a more reasonable profit margin of 12.78% -- or 4-5x price to profit. Still, cheap when looking at historical multiple levels. Below, historical P/E ratio for BAC, 20 year average -- 12.5x.

Historic P/E, FY
30 25 20 15 10 5 0 -91 -92 -93 -94 -95 -96 -97 -98 -99 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 -11

P/B: Looking at another multiple, Price to Tangible Book, the company also comes cheap with a P/B 0.48x compared with a 20 year average ratio of 2.53x.

Historic Price to Tangible Book, Total Equity, FY

4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 -91 -92 -93 -94 -95 -96 -97 -98 -99 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 -11

Going back in the analysis, the second scenario of write-downs, gave us a p/b of 0.72x. Bottom share price for BAC using second scenario of a CET1 $7.31/share multiplied with historical low p/b of 0.45x indicate an absolute bottom price of $3.3/share. ROE: Using the currently stated CET1 in q3-11, BAC is turning over their equity capital 0.78 times. If we use the profit margin of the above 12.78%, we get a ROE of 9.95%, represented as a proxy for future cash flow potential. This compared with the 20 year average historical ROE of 13.2%, see chart below. (pls note that the chart below is calculated on equity stated in the books, not adjusted. Using unadjusted equity would bring down the ROE to 5.4%).

Return on Avg. Common Equity, % (Income Available to Common Excluding Extraordinary Items), FY
25 20 15 10 5 0 -91 -92 -93 -94 -95 -96 -97 -98 -99 -5 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 -11

U.S. Housing units vs. Household Formation.

BAC is an interesting story. It is financially integrated into the American system and is probably one of the purest reflections of the United States economy. So one should also factor in one cornerstone of the health in the US economy the housing market as it is strongly correlated to BACs profitability. According to my interpretation of Warren Buffett, he is saying that one should look at businesses to gain a better understanding of the health of the current economy. Berkshire has more than 70 businesses and those businesses have more businesses, so they have a cross section of American businesses to look at. So looking for example at the big five Burlington, Marmon, Iscar, Midamerican, Lubrizol Berkshire can use these five as a barometer of economic health since these companies cut across industry. All of these businesses are doing considerably better than a year ago, and continue to improve their results. Moreover, he recently stated that one area that is in a depression not recession is anything related to residential construction and that depression has much more effect on unemployment than is generally realized. So, you have one segment that is doing well, and another that is in a depression. The one that is in a depression is what matters the most to BAC and is the one worth monitoring. In the US, a huge inventory of housing units were built up during the first decade of this century and the banks were riding on the wave, then came the bubble in the biggest asset class and financials were hit hard. After the crash, the relationship reversed, creating more households than housing units, drawing down that inventory day by day. Sooner or later, it will come to equilibrium. The average housing unit construction from 1959 2011 is approximately 1,483 million housing units at an annual rate. As of October 2011 it is down to 628000 at an annual rate. When household formation pick up to at least a million, then housing units rate will most likely pick up and banks should see an expansion in margins.

*Home Construction Units 1959-01-01 to 2011-10-01

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Summary
Bank of America could be analyzed ad absurdum, hence I believe it is better to put focus on the business structure and dynamics rather than trying to pinpoint the quantitative data in the book. It has a great underlying deposit franchise and businesses which will continue to earn money through internal generation. The company has its legacy problems and will probably continue to suffer from a bad loan stock over the next coming years while working to get the capital in line with the assets. Every day the company is doing a great job in going back to basics from a previous hundred different directions, bringing down the liabilities, following a logical path that effectively will enable management to turn over the assets to the previous mean of around 0.05x. And coupled with a profit margin of maybe 10%-12%, the business should be providing a nice wave for shareholders to surf on.

2011-04-01