BAC Getting Interesting Again?
Board: Value Hounds
I've been spending more time with BAC. It gets more interesting with the share price around $7.00. BAC is now selling at 0.33 times book value and at 0.53 times tangible book value. This is dirt cheap presuming:
1. The litigation for reps and warranties is not excessive
2. There aren't further large losses in the loan portfolio
3. There isn't large exposure to unhedged PIIGS debt
4. The company doesn't have to raise equity in order to meet Basel III standards.
I covered some reasons why I thought BAC was cheap in my last post about the bank.
But have since read the new 10Q, read more articles, and have done more spreadsheet work, modeling what the losses in the loan portfolio might look like as well as the capital requirements for Basel III. I've also learned more about the litigation against BAC and found out in the latest 10Q that they've established a litigation reserve of $17.8 billion. Last, I listened to the Berkowitz/Moynihan conference call this week. My valuation is still based on an ROE model, but the key is to build the ROE off of a realistically impaired equity base. So here are my current assumptions, tweaked from last time:
Litigation Impairment: $12.2 billion
$12.2 billion accounts for mortgage putbacks and foreclosure settlements. (liability for representations and warranties)
There are $222 billion in total defaulted and nonperforming loans that were sold
BAC settled 60% of the legacy Countrywide mortgages, which represent about 46% of the $222 billion, leaving $120 billion
BAC estimates the potential mortgage putbacks at between $7 to $10 billion or 7%. I'm going with $30 billion or 25% Current claims are $13.6 billion.
BAC has a litigation reserve of $17.78 billion, which will be drawn down before equity is hit.
$30 billion in litigation - $17.78 billion in litigation reserves = $12.2 billion
PIIGS Debt Exposure Impairment: $7.5 billion
BAC has $119 million in net PIIGS sovereign debt exposure after hedging. I'm subtracting all of this, assuming total loss
BAC has $14.845 billion in net PIIGS non-sovereign debt exposure. I'm subtracting 50% of this ($7.4 billion), assuming loss
Loan Book Impairment: $13.4 billion
[See post for tables
Total 30 Days Past Due and Nonperforming: $67,668
Assumed Recovery Rate: 25%
Existing Loan Loss Reserve: $37,312
Assumed loss if all 30 days past due and nonperforming loans are charged off assuming recovery rate: $50,751
Assumed loss minus loan loss reserve: $13,439 Impaired Equity Base
Adding all these losses up and subtracting from the equity base of $221.76 billion gives me an impaired equity base of $188.7 billion. Taking that and just dividing by the 10 billion shares that are out there gives me $18.87 a share in book value.Basel III
A big concern is that BAC will need to raise equity to meet the higher equity holding standards of Basel III that gradually go into effect over the next 7 years. When I look at the amount of capital needed to be raised, even off of an impaired equity base, I'm not seeing that there would be an issue unless the bank was only able to earn a super-low 1-2% ROE over the 2012-2019 time frame.
[See post for tables
It looks to me that BAC could cover the Basel III capital requirements on my estimate off of its impaired equity base comfortably (and that assumes all the losses I estimate are incurred now
instead of over the next several years). A 5% ROE is not a high hurdle rate but I think it's realistic assuming the further writedowns, lawsuits, etc. that will occur over the next couple of years. I expect BAC can achieve a 10% ROE when there aren't writedowns.
This is just one way to model it. You could assume a higher ROE but then you'd have to account for more equity writedowns, or you could assume that RWA gets whittled down some as BAC sells assets. There are multiple ways to get there.Conclusion
I think BAC is cheap. Working through the numbers of the realistic possible losses and requirements for Basel III I don't see an insurmountable problem for the bank. I decided to buy some shares around $7.00 this week. Wish me luck.
Some articles I found helpful:http://seekingalpha.com/article/286617-bank-of-america-it-ha...http://seekingalpha.com/article/284553-bank-of-america-way-b...