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Wednesday, August 24, 2011

Bank of America, Buffet, and Army of Analysts Shut Down Crooked Henry Blodget Sell-Off

Warren Buffett's Berkshire Hathaway will invest $5 billion in Bank of America 
News broke out this morning, pushing BofA higher after this blog post was published yesterday afternoon, encouraging investors to hold on despite what the pundits say. 

Henry Blodget is the CEO and Editor-In Chief of Business Insider and a familiar pundit on Wall Street who loud mouths for or against tech companies depending on his investment objectives. Now banned for securities trading following some questionable predictions during his internet and e-commerce analyst positions at Prudential and Merril Lynch. Gaining popularity, Blodget offered good calls particularly on Amazon.com hitting his price target of $400 per share, and bad calls in which he labeled eToys as a good long term buy back in 1999 - which eventually tanked two years later and had assets acquired by KB-Toys; perhaps a move to prop up share prices to leverage a sell through indirect trading accounts pointing back to his personal stake. Now ousted from the industry, Blodget remains active - with a new target on Bank of America.

Tech guy turned bank guy, Blodget had great power leveraging his platform at Business Insider and connections with big heads on Wall Street to spread fears about Bank of America being under capitalized with great risk exposure. The fears rippled throughout the blogosphere and investors began shorting heavily. A rumor was sparked about JP Morgan preparing to purchase Bank of America with government cash support. Especially at a time when everyone is worrying about economic slowdown leading to a double-dip, negative attention towards US banks is sure to spark big fear -- another 2008-type crisis? No. Take a breather.

The fundamentals are worrying, but not as scary as Blodget and friends make it seem. On July 19th of this year, Bank of America reported a net loss of $8.8 billion ($0.90 per share), largely due to charges resulting form a recent agreement to resolve Country-wide liens on Residential Mortgage-Backed Securities (RMBS) involving a line of $900,000 worth of loan modifications, repurchase exposures, and other related costs. The bank's core business performance this past quarter was held back from higher costs as management absorbed more mortgage issues. With losses canceling out gains and draining cash, investors have good reason to be cautious.

However, Bank of America continues to experience a good inflow of deposits and revenues gained from those holdings. The bank reported $147 billion of new extended credit in the second quarter, an increase in consumer deposit balances by $44 billion (4% from previous year), and more small business accounts equipped with the support of new branch locations and local loan specialists. An increase in Global Wealth clients contributed to $1.6 billion in investment banking fees, the bank's highest since the Merril Lynch acquisition.

Tangible Book Value (TVB) essentially measuring the net-worth, has decreased by about $1 to $12.65 per share from the first quarter of this year. Since the bank is balance sheet driven, investors can use TVB as a rough estimate of its liquidation value - apparently being low. This is a problem; consistently lower TVBs shows that too much of the banks' interest earning assets are covering interest bearing liabilities. Again, the costs on the liabilities side coming from mortgage loan problems.

The financial short-fall is a natural consequence of addressing the mortgage problems head-on, an organic approach taken on by the new CEO. Brian Moynihan is doing a good job with cleaning up the mess from former CEO Ken Lewis who grew a troubled bank. The fact that this is going on internally is great news for the long term investor. Given no immediate disaster in the economy, Bank of America is preparing a sustainable path for itself.

The big worry among investors is that Bank of America may dilute its shares for immediate cash. Not quite. The internal operating overhaul will provide sufficient liquidity for Bank of America to remain solvent. Moynihan is looking at what works, and what doesn't work. More clients, depositors, fees, liquid interest-earning assets, and sales are working well. A sell-off should not be shunned upon; so far 20 assets have been sold under Moynihan's leadership including the Canadian card unit, plans to exit UK and Irish card units, and write downs of credit cards and mortgage units. The power of a write down - reducing the book value because the asset is deemed overvalued - will help Bank of America adjust to reality and manage its operations better. As with most banks, Bank of America is overstaffed with toxic paper pushers, not value creators. The 3,000 layoffs recently marked a significant move to restructuring operations. Shifting labor from what doesn't work, to what works (hence more local loan officers to monitor small business credit lines during economic uncertainty) is a result of good management.

Trusting Moynihan is tricky, but moving forward will hurt in the short term. The rumors will continue, but those who stick to the fundamentals will gain.  The JP Morgan merger is unlikely as Bank of America already has $62 billion in market cap with enough on its plate. External moves will hurt the company, and it knows this -- investors are voicing their opinion that the company should continue internal restructuring, or else risk a sell-off (with a stock price so low, there's not much room to risk such a blow in equity value).

The risk of being undercapitalized is important, but debatable. Basel III capital requirements will force Bank of America to raise $25 billion, according to JP Morgan (not $200 billion according to Blodget). Here's what the army of analysts say:

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Bank of America (BAC) got a new supporter on Wednesday, as analyst Meredith Whitney told Bloomberg Radio that the hemming and hawing over the bank’s need to raise billions in new capital is overdone. “I don’t think that there’s a mad dash to raise capital immediately,” she said. --Barron's
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"There is no impact whatsoever on Bank of America's balance sheet, based upon the price of its stock in the open market. If the price of the stock goes to a penny a share, it has no impact on the balance sheet of Bank of America. Bank of America sells the stock to the public, it takes in the money, and that is the end of the transaction as far as Bank of America is concerned. If you're going to break a bank, you're going to have a run on its deposits. That's not happening. Exactly the opposite is happening…Deposits are pouring into Bank of America."
"Or, as in the case of the fourth quarter of 2008, you've got to bust a bank by making it repay all of its short-term debt immediately. Bank of America has so much cash on its balance sheet that it can pay back all of its short- term debt, it could pay back a big chunk of its long-term debt and still have excess cash on the balance sheet. You can't break the bank by driving the price of the stock lower, particularly if the bank is as cash-rich as this one is with deposits pouring in as fast as they are." --Bank Analyst Dick Bove
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Core Portfolio - Prime mortgages 30 days or more past due increased to 1.98% from 1.67%.
Legacy Asset Servicing Portfolio - Subprime mortgages 30 days or more past due increased to 46.7% from 46.6%.
Commercial – Commercial loans 30 days or more past due decreased to 2.01% from 2.55%.
Credit and Consumer – Loans 30 days or more past due decreased to 3.38% from 3.93%.
Also, 90% of the loan portfolio is paying in a timely fashion.
And 8.5% of the loan portfolio is 90 days or more past due or was purchased credit impaired.
If all of these loans default with no recovery rate, BAC would be looking at $75 billion in future write-downs. With $37 billion already allotted to loan loss reserves, the bank would be looking at a decrease of $38 billion from tangible book value, which held steady near $130 billion. That would still leave the bank with over $90 billion in tangible book value and selling for just 75% of tangible book value. Currently, the bank only sells for half of tangible book value, an unprecedented valuation.
For Bank of America to become insolvent, 14% of its loan portfolio would have to default with no recovery rate. With only 8.5% of loans currently 90 days or more past due and/or purchased credit impaired and almost assured to have some recovery rate, this would mean defaults would have to at least triple for the bank to become insolvent, a level much worse than the depths of the recession in 2009. -- Matt Blecker 
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This is nothing like 2008, says CEO Brian Moynihan. "Simply put, we have twice the capital we did back then," he said on a recent conference call. B of A currently has twice as much capital as regulators require. New international banking standards called Basel III require large banks to hold 9.5% Tier 1 common equity, phased in between 2013 and 2019. B of A says it will already exceed 8% next year. Seven years to raise less than two percentage points of capital is hardly onerous, particularly since B of A isn't paying dividends to shareholders. As for aneverending stream of lawsuits caking the bank in uncertainty, Moynihan said he isn't going down without a fight. --Motley Fool