Inside Financial Services

Why We Own Bank of America

Don't rub your eyes. That's not a typo.

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On Bloomberg TV yesterday morning, Betty Liu almost fell off her chair when I told her that after all these years, the investment fund I manage has at last taken a position in Bank of America (BAC).

Say, get up off the floor! Yes, BofA is still, for the most part, the same BofA I’ve been complaining about for years: a lumbering bureaucracy of walled-off fiefdoms that don’t do much especially well, all overseen by a management team about which I have my doubts. Hugh McColl and Ken Lewis may be gone, but the deadening “culture” they fostered, of get-big-no-matter-what-and-then-it’s-every-man-for-himself, still pervades the place. I wouldn’t want to work there. No one is going to mistake BofA for Wells Fargo or JPMorgan Chase any time soon. So stipulated.

But-and this is a very big but-the stock is cheap. Really cheap. At current levels, Bank of America trades at all of 56% of its stated book value. At a price that low, one can invest in what is, after all, attractive franchise (although run by a mediocre management) and still earn attractive returns. By way of contrast, Wells trades at 125% of book, while Morgan trades at 100% of book.

It’s no secret why BofA trades at such a big discount, either. Following the housing collapse, the company faces by far the most mortgage put-back claims of any of the big home lenders. (It can thank the Countrywide acquisition for that.) In particular, MBIA is suing BofA over reps and warranties it made regarding $21 billion in Countrywide MBS that it agreed to insure. Pimco is suing over $47 billion in MBS. (BofA settled with Fannie and Freddie at the end of last year.)

Those are big, scary numbers-the kind that drive investors away and keep them there. Until the claims are resolved and BofA’s liability actually known, the stock isn’t going anywhere.

Now, I have no specific knowledge as to what’s going on at BofA, either in the boardroom, the legal department, or Brian Moynihan’s head. But I’m willing to bet that the longer the stock lingers down here in the weeds, the greater will be the pressure (and the wish) to bring the put-back matter to a conclusion. The final settlement may not be optimal, but it will be a number that everyone can live with so they can all move on. And, I suspect-again, with no specific knowledge-that such a settlement could happen sooner rather than later. And when it does happen, BofA’s stock figures to move up substantially in a very short period of time.

And if I’m wrong? Well, I still own the company at 56% of book.

And, as I say, BofA’s franchise is attractive. The company is a strong deposit gatherer, while Merrill Lynch is well-positioned to benefit from the recovery in the capital markets business. The card business is getting better, as well.

No, this isn’t the biggest position in our portfolio, but it’s in there. At this price, I like the risk vs reward.

What do you think? Let me know!

29 Responses to “Why We Own Bank of America”

  1. Anonymous Wall Streeter

    My mom’s for sale, at the right price. She can cook and clean. Make me an offer.

  2. john

    You make the same (misguided) argument that all BofA bulls have made for years – it’s cheap. BofA has potential, but I doubt if it ever gets realized. It’s a value trap.

    But I’m sure this will turn out great for you, just like SNV and FMD. Ha!

  3. goodluckyouneedit

    Maybe you’re right on BAC. Hope so b/c your holdings in SNV & CCRT haven’t fared so well.

  4. Peter Hallowell/late of DLJ etc.

    Fan me with brick.

  5. craig woodruff

    i’d love to buy BAC in the single digits again but i doubt if that is a realistic expectation . as usual , you have made an excellent case for a modest long position .
    respectfully yours ,
    craig woodruff

  6. rivvir

    “Well, I still own the company at 56% of book.”

    What do you expect book to be if/after they settle? I don’t doubt it’s worth a shot but i don’t know that current book value is reflective of a substantial settlement. Anyway, good luck, to both of us, i’ve got a bit, a very small bit, as well

  7. john morris

    Interesting on B of A. I see you continue to acquire PRS. What is your current thinking..?

  8. banker2002

    with so so many bad loans i would take the other side of this trade lossing 20%+ still is lossing when i can buy banks with no issues at cheaper than that while no as liquid they have takeout potential and usally pay 5% cash dividends while I wait and sleep , with BAC you could not sleep, they have so many real estate loans they made themselves that they will lose 60% of their money on if not all of it and some loans i here they even just forgot about, beware bac would be long gone if not for the goverment down side zero to $8 under side $15-20 in maybe years not good risk reward.
    BARI just got a 60% pop there are many more of those to come
    banknewsletter.com
    douglas
    hughes

  9. banker2002

    with so so many bad loans i would take the other side of this trade lossing 20%+ still is lossing when i can buy banks with no issues at cheaper than that while no as liquid they have takeout potential and usally pay 5% cash dividends while I wait and sleep , with BAC you could not sleep, they have so many real estate loans they made themselves that they will lose 60% of their money on if not all of it and some loans i here they even just forgot about, beware bac would be long gone if not for the goverment down side zero to $8 under side $15-20 in maybe years not good risk reward.
    BARI just got a 60% pop there are many more of those to come
    banknewsletter.com
    douglas
    hughes

  10. alex lieblong

    at about 3 times core earning its worth the wait

  11. john

    3x core earnings?? Alex, where did you get those numbers? Do you really think BofA is going to earn $4 in EPS anytime in the next decade? Keep dreaming.

  12. Jonathan finger

    I think a better metric is Price to tangible Book Value. Stated book value contains plenty of goodwill that one can easily argue has been destroyed by a management team that managed for short term growth rather than long term value. Just look at the $1 BN goodwill writedown they took in the card business at YE 2010, or actually Q1 2011, but effective back to YE 2010. Ooops!

    Also, their card business is still the worst in the business by any metric – charge offs, delinquincies, pay rate, etc. Worse than Advanta – which is admittedly sub prime, chy B of A claims to be prime. Also, count the lawsuits. They are piling up.

    I think the stock is dead money for at least 1 year. Cheap, but how long do you have to wait.

  13. mark346

    Tom, thanks for your thoughts, you may be correct, however the reason the stock MAYBE fairly valued now is as follows.
    What if BAC has to pay out 21 billion to MBIA ?
    46 billion to PMICO ?
    34 billion to others ? [just a wild guess !! 21 +46=67billion /2=34+-billion]
    Total of the above…101 billion .
    remove that from the current book value of 212 billion and you get adjusted book value of 111 billion.
    So the example above means the book value is now trading at 107% of book value. 119/111. Not 56%
    ……….Real world tells me they settle for far less ,maybe 10 to 20 billion ,but it’s not a lay up and timing is a real issue. The folks suing smell blood. Maybe buying stock and buying puts for protection may be a interesting approach.[you don’t buy protection as far as I know] Thanks for your thoughts

  14. jsc173

    Brave man. I still don’t believe that anyone, least of all their senior executives and for sure not an independent analyst, know the sum of the embedded losses in the loan portfolios of the “big four.”

  15. grover13

    Tom-

    I applaud the sentiment, but you’re not thinking this through. Yes, their price-to-book may be cheap. And yes, the mortgage exposure is likely the main culprit in depressing the stock price. So, let’s look past that to what we have left. To your stated points:

    – A company who’s strategy was to grow via acquisition above all else, in a quest to become a “one stop shop” of financial services.
    – A company whose internal departments do not play nicely with others
    – A company who has no singular culture; just a fragmented conglomerate of it’s past acquisitions
    – A company who, credit and market risks aside, has significant challenges to overcome in that the operational systems from the companies they acquired are not compatible with each other.

    In short….what you have is Citigroup, circa 1999. Citi stock was virtually asleep through much of the last decade- that is until 2007, when it began it’s 90% decent.

    So, to put it all together, you have the size, scope and strategy of a company who attempted the same thing a decade ago- and failed miserably- and then you have severe mortgage-related risks on top of that that will take years to play out.

    Have to question your judgment on this one, Tom.

  16. DLB

    Good luck to you. I’d rather buy any of dozens of small banks (under $5 billion) trading at less than TANGIBLE book with few loan problems and many a reason to sell out at a premium in this much more difficult operating world.

  17. Jack

    well, after making bets on FMD, MRH and SNV ( cheap at $3.35) I am almost broke….non kidding!

  18. Responsible Loan Officer

    I think you are crazy!

  19. mopedman

    Well odds are it’s far better in the long run to buy a stock at half it’s value than for more than what it’s worth. The very fact it is selling for half is a prime example that what we actually have going here is a popularity contest and BAC right now just has to clap and act thrilled when everyone else wins. Long since forgotten by both man and government is some of this stuff got shoved down it’s throat. We’ve rotated back and forth from clouds to oil and have skipped banking for quite some time now..does anyone else remember the days or was it day when banking actually led the market up? I think after things clear up, they may get their turn again. Right now I’m into regionals for the pop when the buyouts start and hope the one I own isn’t first. I even bought some NBG for the shear fact that people can’t stand to not go nuts over it for very long. Compared to the gut wrenching experience the past few days with oil services and farm equipment, banking looks a whole lot better right now. BAC..might as well.

  20. alex lieblong

    its funny that some one does not understand core earnings an thinks that means eps

  21. sam

    MBIA records its expectation of realized liability at $2.7bn, time valued. folks should do the work on the putback risk. The analysis above could be bolstered by the same. We are getting the components in place to make a case for something more similar to $15bn liability, a manageable number and about 2 quarters worth of core earnings genaration off the $1trn of 33bp deposits. ALso, on SIFI capital requirements, you have to have a view on whether they will be 8%, 9%, or 10%. if you believe $15bn and 8% then longs may end up happy. $4 annualized PTPP.

  22. Tom is No Headhunter

    Nobody wants to work at Wells Fargo either

  23. BAC holder

    I was at a presentation where Bruce Berkowitz of Fairholme Funds was speaking. He is bullish on BAC also.

  24. TRENDEQ

    Buying and I bet we see $19.00 by late fall. Thanks for the update on your position. Also, great interview on Bloomberg!

  25. BAC to C

    Tom – 12.25 …. Scoreboard 10.54….. the bears are ripping your portfolio risk management apart.

  26. recession12

    56% of book? How do you know this? A trillion dollar balance sheet can be fiddled with in many ways. I don’t believe valuations, and don’t like there gambling arm ( Merrill Lynch ) as being very transparent. Banks are done, cooked here comes 2008 again. Get out of BANKS!!!!!

  27. Susie Q

    Thomas, I know this is a little late in coming, but I happen to have a couple of things to add.

    BofA compensated bankers on the volume of loans the banker acquires, not how by how profitable those loans were to the bottom line. The system did not seek to protect the shareholder or the individual banker, but the manager who was able to put the assets in his profit center. The net result was that BofA bankers made little real ROE return for the bank and did lots and lots of below market loans. BofA offset the lack of yield through the bloody and aggressive policy of buying other, more profitable banks. Those portfolio yields (and the tremendously low cost of bank funds) skew the way BofA states the return on which the stock value is calculated.

    Now that it can’t buy anymore banks, how can it make itself profitable? The same predatory management style is still in place, and the regional C-suites contain the same old warriors.

    I hope to God you are right because I have BofA pension (acquired when BofA purchased my more profitable employer). But, I have to agree with my pals in the comments section.

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