|Shares Out. (in M):||10,130||P/E||0.0x||0.0x|
|Market Cap (in $M):||64,860||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
Bank Of America equity is worthless. CFC-related litigation is going from bad to worse, it can lead to violent erosion of shareholders' equity which. Combined with the run on the bank that has slowly begun, the $53 trillion in derivatives, the lack of sustainable competitive advantages and the depleting political influence, I believe this is a terminal short.
Basel III for quantitative context
Sometimes you get so used to seeing something wrong that you just forget how wrong it is. Therefore, a key to analyzing the situation is to zoom out and look at the forest. Let me talk about something that is NOT IMPORTANT to the thesis but that will help to zoom out. Here's an industry that has developed a new set of rules - Basel III - that for semi-understandable reasons cannot easily be implemented immediately. Ok. But that implies that as long as they aren't (and BAC isn't done implementing them), present leverage levels are still dangerous. Not every industry operates with openly-acknowledged problems like this. (and Basel III was designed by/with the industry!) . Now consider the following: this issue is nothing compared to what we'll mention in this write-up.
Robosigning scandal for qualitative context
Now, let's do the same kind of zooming out from a qualitative perspective using the robosigning scandal as an example. Here's an excerpt from an article on one robosigner: "He spent so many hours writing his name that his signature morphed into a series of four circles overlapping one another. He said that he and his co-workers joked that they got so used to the rapid-fire signatures that they started signing personal paperwork that way". Consider that this is just one little fraud out of the multiple frauds committed by Bank of America, Countrywide and Merrill.
So now we have some context about the company being written up. Let's dig in. Here's what I will discuss:
- Sustainable competitive disadvantages and Potential Run
- Management Incompetence and Dishonesty
- Derivatives Exposure and Recent Decision to Move Them into Bank Sub
- Waning Political Support
- Countrywide and Mortgage Litigation
- Recession as a Risk
Sustainable competitive DISadvantages and Potential Run
BAC vs. going to a community bank
Some may claim that BAC has a brand name and scale and an ATM/branch network that enables it to capture cheap deposits and build a moat. This is wrong.
The word credit comes from the word credibility. When you deposit money in a bank (above FDIC limit) you're putting your faith in its solvency. When you take a loan you're putting your faith in the banker's future willingness to do friendly loss mitigation in case anything bad happens. BAC got almost as far from its customers as one could get. This has resulted, and I don't need to elaborate, in mortgage portfolios that performed quite badly compared to a local banking set-up. And deposit-wise and investment-wise BAC doesn't do much for customers either. It's a commodity business, especially for the bigger banks.
More trust ultimately allows a bank to make more NIM. For example: you have a choice between BAC and a community bank that dealt with your father for 40 years. You can be reasonably certain that you won't be illegally and unethically foreclosed upon if SHTF. Would you not pay a few more bps to a community bank? Admittedly it's not all apples-to-apples but the principle holds true.
Centralized top-down underwriting and fee and other policies lead to loans being given to people that can't afford it AND refusal of loans to people who CAN pay back. It also prevents the bank from building long-term relationships locally.
Not only is there a lack of local relationships but there are bad national relationships dictating the outcome. That is to say, with PR disaster after PR disaster, the population learns to hate BAC on a national level and they then proceed to view their local BAC branch as part of a terrible institution, thus eroding potential for local relationships, confidence, and trust.
Poor Historical Record
And the idea that BAC can't compete vs. smaller banks is supported by the company's history. BAC is the WorldCom on banking. People talk about how value-destroying the MER and CFC deals were but it goes back even further. With MBNA and FleetBoston it was the same thing. Tom Brown had written plenty on the mesmerizing capital allocation decisions of Ken Lewis. That CEO had only one goal in mind: empire building
BAC doesn't currently make money. If it did, it would volunteer to use MTM accounting despite FASB's favors. We know in 2009 they were insolvent and desperately needed cash. Lots of cash flow since is not sustainable. BAC recently got billions in commissions from the Fed for POMO trades that have add no value. Just flipping treasuries to the Fed... profits were higher when long rates were higher. The Fed has for now bootstrapped the curve so we'll see where that goes, but that's how you make money when you're desperate and you have no sustainable competitive advantage. You influence government to do these things. Another point proving that big banks and investment banks like Merrill don't have the biggest moat is that the industry blew up in 1983 and 1991 and got bailed out then too.
Sticky & Cheap Deposits Guaranteed? No.
BAC is experiencing the begging of a bank run ALREADY. Although the velocity is not parabolic at this point, the sustainability of the movement is actually stronger than the cases of WaMu or Northern Trust because it is driven by *sustainable* passionate hatred of the bank, not simply desire to pull one's money before others do. Some people are pulling the money out in protest, and no level of interest rates will satisfy them. The following 3 videos demonstrate the situation very well:
....Especially Not With New $5 Debit Card Fee...
November 5th is Bank Transfer Day - it was created to protest a new policy by the big banks of charging debit-card fees. WFC and JPM are charging $3 a month. BAC made it $5. More details in this short interview with the CEO of Credit Union National Association:
And here's a concrete manifestation of BAC's non-moat: there's a bank that offered the inverse: a monthly $5 payment.
"Community Bank, which has 17 branches throughout Manatee and four other southwest Florida counties, is joining the outcry against bank debit fees by offering new customers the opposite: a monthly payment. The $5 per month Community Bank is offering anyone who opens a Value Checking account is a direct response to the $3 to $5 monthly debit card fees larger banks are starting to charge, bank officials said.
Pembles said Community Bank has received an overwhelming response to its offer, with customers opening up accounts in every branch. She said even existing customers had expressed support for the special offer, even though it applies only to new customers."
Senator Durbin Hopping on to the Bank Run:
"Bank of America customers, vote with your feet, get the heck out of that bank," Durbin said on the Senate floor. "Find yourself a bank or credit union that won't gouge you for $5 a month and still will give you a debit card that you can use every single day. What Bank of America has done is an outrage." Durbin said consumers are rightfully outraged about last week's announcement."
Management Incompetence And Dishonesty
Lack of Management Credibility
In August they said "we don't need capital" and then accepted Buffett's deal which can dilute the stock and is expensive. i.e. they either lied about capital or they truly didn't need capital and therefore violated fiduciary duty by accepting it. Catch-22.
But they probably needed it because a day later they sold the CCB shares plus they issued Employee talking points in the run-up:
Lack of Management Talent:
They knew that CFC and Merrill were very bad acquisitions, how could they not? How could you do due diligence on Merrill in a day? How could you take CFC with the mortgage mess at the time? Same for fleet and MBNA. Capital allocation otherwise has been generally poor.
Lack of Management Honesty and Decency:
From Bill Black: "Bank of America has delayed foreclosing, sometimes for years, on large numbers of loans that have no realistic chance of being brought current, even with the loan modifications it offered. This behavior would be irrational for an honest lender, for it would increase ultimate losses, but is a typical strategy for a lender controlled by fraudulent senior officers because it greatly delays loss recognition and allows them to extend their looting of the bank for years through bonuses paid on the basis of fictional reported "profits" after the bank has (in economic substance) failed."
They are being trusted with marking assets (FASB suspended MTM). Think they're doing an honest job?
Derivatives Exposure And Transfer Of Derivatives Into Bank Sub
Last month they got 2-notch downgrades from Moody's: holding company was downgraded to Baa1 and bank sub to A2. This week the company announced that derivatives at the holding company will be transferred to the bank sub - done at request of counterparties according to Bloomberg. (When BAC bought MER it placed MER's derivatives in the holding company). The Fed ok'ed the move, FDIC opposed it. Now, JPM also holds derivatives in the bank except Merrill's derivatives and JPM's derivatives are not the same! MER must have more dangerous credit derivatives, probably more garbage generally AND it has not been supervised like JPM or C because of its different regulatory status. Another interesting point: GS and MS run large, presumably well-enough-managed derivatives books, at least to the extent that its customers do not need a deposit base to feel safe! So it sounds like something bad happening at Merrill or maybe it's a move to protect the holding company from collateral calls. Depending on what is going on, this may end up being fraudulent conveyance. Again, the FDIC opposed this. Two important reactions
1) Bill Black comparing to S&L:
"As S&L regulators, we recurrently faced this problem. First, the holding company's controlling managers are a severe problem because they are seeking to exploit the insured institution. Second, the senior managers of B of A acceded to the transfer, apparently without protest, even though the transfer poses a severe threat to B of A's survival. Their failure to act to prevent the transfer contravenes both their fiduciary duties of loyalty and care and should lead to their resignations.
We took depositions during the S&L debacle in which senior officials of Lincoln Savings and its affiliates were shocked when we asked "whose interests were you representing - the S&L or the affiliate?" They had obviously never even considered their fiduciary duties or identified their actual client. We blocked a transaction that would have caused grave injury to the insured S&L by taking the holding company (Pinnnacle West) off the hook for its obligations to the S&L."
2) Occupy Wall Street Considering Making Statement on This:
Waning Political Support
From the September 21 Moody's downgrade:
"The downgrades result from a decrease in the probability that the US government would support the bank, if needed. Moody's believes that the government is likely to continue to provide some level of support to systemically important financial institutions. However, it is also more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled, as the risks of contagion become less acute. Moody's is therefore lowering the amount of support it incorporates into Bank of America's ratings to levels reflected prior to the crisis."
Also, nationalization in Europe will put pressure on US to do same because of Occupy Wall Street and other political pressures. And also Occupy Wall Street in general is a big game-changer. In 2010, a year where the economy suffered using any of your favorite charts, bankers made record bonuses. Anger is all over. I saw 2 women discuss the bailouts last night on a quiet street and I live in Canada.
The movement started on September 17th and the downgrade was on the 21st, i.e. when the movement was nothing. So BAC deserves more downgrades based on the declining-bail-out probability factor.
There is a chance that unexpected debt relief will have to be forthcoming as part of the solution to the people's grievances. It can really get ugly for BAC. The political dimension is definitely a black swan.
Countrywide and Mortgage Litigation
Let's start with the ending, will BAC file chapter 11 for CFC and rid itself of exposure? After all, Moynihan said he wouldn't rule it out. My answer is no for two reasons that Weil's Harvey Miller, among others, has stressed:
(i) It puts into question the parent's support for its other subs. Merrill will likely suffer from liquidity issues immediately. Maybe even the bank sub. Financial companies in liquidation are a mess
(ii) The relationship is complicated between CFC and BAC. Is there really no connection? When BAC acquired CFC it moved assets from it to the holding company. If there's a chapter 11, litigation over this will ensue. As a matter of fact, the AIG putback lawsuit against BAC already has a long section opining that BAC is liable as well.
So how exposed is BAC's tangible book of about $150 billion to litigation?
The $8.5 billion putback settlement with Attorney Generals imploded yesterday actually, though it was already in great jeopardy. The lawsuit was originally filed in New York State Court which allows a quick resolution where most plaintiffs have no say. One plaintiff filed a request to transfer the lawsuit to Federal Court and the judge now agrees because "there's no analogous procedure for binding thousands of investors in 530 trustees to a settlement only 22 of them had a hand in negotiating". A better figure is in the $20+ billion if one assumes all these defective securities must be accounted for and not just 40% as done in the projections for the initial settlement proposal. That takes us to shareholders' equity of about $125 billion.
Then, the FHFA sued for $31 billion. Let's say they settle for 66%, that takes SE to $105 billion
Then there's MBIA, Landesbank, Norway's Sovereign Wealth Fund and others will come. MBIA has won some key ruling already. Let's not even count them
Apart from lawsuits, the bank needs to write down, say, $50 billion of 2nds, that takes SE to $55 billion, below the common's current market cap.
But with write-downs like this, the company would have to patch up its capital ratios, it would therefore have to dilute its stock. If dilution double shares outstanding, per-share tangible equity halves. Not unrealistic in a world of panic. And they'd have to get that from the private market due to the no-bail-out political climate. Thy could put in place an Asbestos solution: fund a litigation trust. Looking at other options, Dodd-Frank probably can't resolve CFC because CFC is not systemically important. So it can get messy, and this is without taking into account derivatives, without a bank run, without Occupy Wall Street and without recession.
Recession as a Risk
ECRI, John Hussman, David Rosenberg, other reliable investors/analysts and even bank research departments, through their weird % recession likelihood system, all agree that the U.S. is entering recession just about now.
The banks have reduced loan loss provisions during the rebound in a recession these provisions will skyrocket. Write-ups will become writedowns. Moynihan said on the Fairholme conference call that all bets are off if there is a serious double-dip
I could have raised a few other issues, but this is enough. BAC is cornered politically, it is hated, is has no franchise, no real competitive advantages, no easily predictable NIMs of any type, tons of derivatives, tons of lawsuits... it's a dishonest accounting mess that serves no other purpose than to compensate its people. And a leveraged mess like this is usually worth zero.
- Recession, weakness in home market
- CFC litigation gone bad
- More downgrade and/or spiral
- Derivatives spark lights fire
- European/Asian economic jitters
- Run on the bank
- Population asserting itself
- Specific demands from population
- action by judicial branch
- action by administrative branch
- action by legislative branch
|Subject||RE: RE: Thesis leaked. Already.|
|Entry||10/20/2011 03:59 PM|
Does anybody else think zerohedge posted that story mainly to take a shot at Tilson? Gotta love it.
|Entry||10/20/2011 05:09 PM|
The derivatives figures are totally bogus and ZeroHedge is just whipping unsophisticated people up into a frenzy. 53T is a number that doesn't compute because it isn't real, it's a gross number that doesn't represent the netted economic reality. And just because there are derivatives doesn't mean they are loss making for the bank. Derivatives are complex and not everyone can understand them, but that doesn't mean they are nefarious.
On the litigation side, if the putback settlements are nullified then BAC gets to litigate these claims over many years, deferring the capital hit and building up capital reserves in the meantime.
On the fudning side, there are plenty of deposits that are locked in via CDs, time deposits, etc. Some customers will move because of the fees (which BAC can decide to drop if need be) but there are many customers who do online bill pay, mortgage payments, etc through BAC and they won't want to deal with the hassle of switching. Obviously this could change in a run, but...
If there is a run on the largest bank in America (5th or 6th largest in the world I believe), all hell will break loose in this country and across the world. It won't be allowed to happen. Don't forget that the government coerced BAC into a quick merger with Merril Lynch back during the crisis and several government or quasi government entities are responsible for a lot of this pressure on BAC (Fannie putbacks, Durbin, challenge to private settlements, etc). Government officials may talk a big game against the big bad banks but what would they do if the fabric of the country was challenged by a teetering BAC?
|Subject||$5 fee dropped|
|Entry||11/01/2011 12:14 PM|
This is a sign that significant political pressure exists on the banks and that public battles can succeed in eroding their profits. I believe this will embolden the citizens to take even more stabs at BAC.
|Subject||Georgia's Democratic Party Treasurer|
|Entry||11/14/2011 12:13 AM|
The Georgia Democratic Party Treasurer destorys a BAC card and urges people to withdraw their deposits from the big banks.