The history of Bank of America dates back to 1904, when Amadeo Giannini founded the Bank of Italy in San Francisco in an effort to cater to immigrants denied service by other banks. When the 1906 San Francisco earthquake struck, Giannini was able to scavenge all deposits out of the bank building and away from the fires. Because San Francisco's banks were in smoldering ruins and unable to open their vaults, Giannini was able to use the rescued funds to commence lending within a few days of the disaster. From a makeshift desk consisting of a few planks over two barrels, he lent money to anyone who was willing to rebuild. Later in life, he took great pride in the fact that all of these loans were repaid.
In 1922, Giannini established Bank of America and Italy in Italy by buying Banca dell'Italia Meridionale, the latter established in 1918. On March 7, 1927, Giannini consolidated his Bank of Italy (101 branches) with the newly formed Liberty Bank of America (175 branches). The result was the Bank of Italy National Trust & Savings Association with capital of $30 billion and resources of $115 billion.
In 1928, A. P. Giannini merged with Bank of America, Los Angeles and consolidated it with his other bank holdings to create what would become the largest banking institution in the country. He renamed the Bank of Italy on Nov. 3, 1930, calling it Bank of America.
Following the passage of the Bank Holding Company Act of 1956, BankAmerica Corporation was established for the purpose of owning and operation of Bank of America and its subsidiaries.
In 1997, BankAmerica lent D. E. Shaw & Co. a large hedge fund, $1.4 billion in order to run various businesses for the bank. However, D.E. Shaw suffered significant loss after the 1998 Russia bond default. BankAmerica was acquired by NationsBank of Charlotte in October 1998 in what was the largest bank acquisition in history at that time. The combined bank still operates under Federal Charter 13044, which was granted to Giannini's Bank of Italy on March 1, 1927.
Ken Lewis and Acquisitions:
In 2001, Bank of America CEO and Chairman Hugh McColl stepped down and named Ken Lewis as his successor.
Ken Lewis made the following acquisitions under his leadership.
|2006||UNITED STATES TRUST COMPANY|
|2007||LASALLE BANK CORPORATION|
Ken Lewis resigned as of Dec. 31, 2009, in part due to controversy and legal investigations concerning the purchase of Merrill Lynch, and Brian Moynihan became president and CEO effective Jan. 1, 2010.
Business and Franchise Value:
Bank of America is a Delaware corporation, a bank holding company and a financial holding company.
As of Dec. 31, 2011, BAC had approximately 282,000 full-time equivalent employees.
At Dec. 31, 2011 BAC held approximately 12 percent of the total amount of deposits of insured depository institutions in the U.S.
BAC operates in 50 states, the District of Columbia and more than 40 countries; its retail banking footprint covers approximately 80 percent of the U.S. population. and serves approximately 57 million consumers with 5,700 banking centers and 17,750 ATMs.
BAC management under Brian Moynihan and Charles O. Holliday Jr. leadership has done an excellent job of increasing BAC franchise value, tackling legacy issues, selling the non-core assets and reducing long-term debt.
Under new leadership, BAC has exited from the reverse mortgage origination business, first mortgage wholesale acquisition channel and proprietary trading business as of June 30, 2011, and reduced its stake in China Construction Bank. It also sold Balboa Insurance Company’s lender-placed insurance business, Canadian consumer credit card portfolio, First Republic Bank, Canadian consumer credit card portfolio, its MasterCard position, and is looking to get out of the non-U.S. credit card business.
Under new leadership, BAC initiated Project New BAC which is a two-phase, enterprise-wide initiative to simplify and streamline workflows and processes, align businesses and costs more closely with overall strategic plans and operating principles and increase revenues to reduce expenses.
Management has done an excellent job in reducing the long-term debt from $438 billion to $372 billion in past three years.
|Long Term Debt (In Billions)||2009||2010||2011|
|Total Long Term Debt||438||448||372|
Note: BAC is not liable for legacy Merrill Lynch debts.
|Tier 1 Common Ratio||7.81%||8.60%||9.86%|
|Tier 1 Common Amount||$120,394||$125,139||$126,690|
|Tier 1 Ratio||10.40%||11.34%||12.40%|
|Tier 1 Leverage Ratio||6.88%||7.21%||7.53%|
|Tier1 Leverage Amount||$160,388||$163,626||$159,232|
Note: Amount is in millions
BAC has done a decent job in increasing Tier 1 common ratio and decreasing risk weighted assets.
BAC has excellent franchises in Deposit Services, Card Services, Global Commercial Banking, Global Banking & Markets and Global Wealth & Investment Management.
Theses franchises have earned pre-tax income excluding goodwill impairment charges and provision for credit losses of $37.3 billion, $50.2 billion, $28.8 billion and $28.7 billion, respectively in 2008, 2009, 2010 and 2011.
The problem segment for BAC is its Consumer Real Estate segment. BAC has paid a huge amount in the last four years for its past mistakes.
|Other general operating||$7.4||$14.9||$16.2||$21.1|
|Provision for credit losses||$26.8||$48.5||$28.4||$13.4|
|Merger and restructuring charges||$0.9||$2.7||$1.8||$0.6|
BAC with excellent franchise earning power and sale of non-core assets has been able to keep down losses in spite of huge payments due to legacy mistakes.
BAC will continue to pay large amounts for legacy mistakes, but when legacy problems are solved, BAC has excellent franchises to earn a net income of $18 billion to $22 billion every year.
1) Loans and Leases
a) Residential Mortgages:
|Excluding Countrywide PCI and Fully Insured Loans||2010||2011|
|Outstanding (in Millions)||$180136||$158470|
|Refreshed LTV greater than 90 but less than 100||11%||11%|
|Refreshes LTV greater than 100||24%||26%|
|Refreshed FICO below 620||15%||15%|
|2006 and 2007 Vintages||40%||37%|
Countrywide PCI residential loan mortgages outstanding in 2010 and 2011 are $10.5 billion and $9.9 billion, respectively.
a) All loans which have a loan-to-value ratio of greater than 90 defaults. BAC gets 50 percent of property value by selling foreclosed properties.
Total amount of loss = 50/100 * 37/100 * $158.4 billion ~ $30 billion
b) 50% of already written-down PCI loans default.
= 50/100 * $9.9 billion ~ $5 billion
Total loss from residential mortgage portfolio = > 30 billion+ 5 billion = 35 billion
b) Home Equity Loans:
|Excluding Countrywide PCI and Fully Insured Loans||2010||2011|
|Refreshed LTV greater than 90 but less than 100||11%||11%|
|Refreshes LTV greater than 100||30%||32%|
|Refreshed FICO below 620||12%||12%|
|2006 and 2007 Vintages||47%||46%|
Countrywide PCI Home Equity Loans outstanding in 2010 and 2011 are $12.5 billion and $11.9 billion respectively.
c) All loans which have loan to value ratio of greater than 90 defaults.
Total amount of defaults = 43/100 * $112.7 billion ~ $48.5 billion
d) 50% of already written down PCI loans default.
= 50/100 * $11.9 billion ~ $6 billion
Total loss from Home Equity Loan portfolio = > $48.5 billion+ $6 billion = $54.5 billion
c) Credits cards, other consumer loans and commercial loans
Over the past four years these portfolios have improved considerably and worst scenario loss for these portfolios at maximum would be approximately $ 12 B
2) Representations and Warranties
Government Sponsored Entities:
Bank of America and legacy Countrywide sold approximately $1.1 trillion of loans originated from 2004 through 2008 to the GSEs. As of Dec. 31, 2011, 11% of the loans in these vintages have defaulted or are 180 days or more past due (severely delinquent).
At least 25 payments have been made on approximately 65% of severely delinquent or defaulted loans. Through Dec. 31, 2011, BAC has received $32.4 billion in repurchase claims associated with these vintages, representing approximately 3% of the loans sold to the GSEs in these vintages. Including the agreement reached with FNMA on Dec. 31, 2010, BAC has resolved $25.7 billion of these claims with a net loss experience of approximately 31%.
Loans defaulted or are 180 days or more past due = 11/100 * $1100 billion = $121 billion
a) BAC has to repurchase all defaulted loans, i.e $121 billion ($25.7 billion have been resolved)
With loss experience of 50%
Total loss on remaining repurchased claims = ($121 billion - $25.7 billion) * 50 /100 ~ $48 billion
Legacy companies and certain subsidiaries sold loans originated from 2004 through 2008 with an original principal balance of $963 billion to investors other than GSEs (although the GSEs are investors in certain private-label securitizations), of which approximately $506 billion in principal has been paid and $239 billion has defaulted or IS severely delinquent at Dec. 31, 2011.
As it relates to private-label securitizations, a contractual liability to repurchase mortgage loans generally arises only if counterparties prove there is a breach of the representations and warranties that materially and adversely affects the interest of the investor or all investors in a securitization trust or of the monoline insurer or other financial guarantor (as applicable).
I believe BAC has adequate reserves set for non-GSE representations and warranties.
I believe BAC has adequate reserves for litigation-related matters.
4) Mortgage Servicing Rights:
Mortgage and housing market-related risks may be accentuated by attempts to forestall foreclosure proceedings as well as state and federal investigations into foreclosure practices by mortgage servicers. Delays in foreclosure sales may result in additional costs associated with maintaining property or possible home price declines, resulting in a greater number of non-performing loans and increased servicing advances and may adversely impact the collectability of such advances and value of MSR assets, MBS and real estate-owned properties and failure to satisfy obligations as servicer in the residential mortgage securitization process, including obligations related to residential mortgage foreclosure actions.
Total corporation mortgage servicing portfolio included $1029 billion in Home loans and $734 billion in Legacy Asset Servicing at Dec. 31, 2011.
Total corporation mortgage serviced for investors included $831 billion in Home loans and $548 billion in Legacy Asset Servicing at Dec. 31, 2011.
|Mortgage Servicing Rights||$12.7 B||$19.4 B||$14.9 B||$7.3 B|
|Mortgage loans Serviced for Investors||$1654 B||$1716 B||$1628 B||$1379 B|
I believe the fair value of MSR appropriately considers all the risks involved with Mortgage servicing.
The Legacy Asset Servicing portfolio includes residential mortgage loans, home equity loans and discontinued real estate loans that would not have been originated under BAC underwriting standards at Dec. 31, 2010. Countrywide loans that were impaired at time of acquisition (the Countrywide PCI portfolio) as well as certain loans that met predefined delinquency status or probability of default threshold as of Jan. 1, 2011, are also included in the Legacy Asset Servicing portfolio.
5) Europe Exposure:
Total sovereign and non-sovereign exposure to Greece, Italy, Ireland, Portugal and Spain, was $15.3 billion at Dec. 31, 2011, compared to $16.6 billion at Dec. 31, 2010.
Total net sovereign and non-sovereign exposure to Greece, Italy, Ireland, Portugal and Spain, was $10.5 billion at Dec. 31, 2011, compared to $12.4 billion at Dec. 31, 2010.
6) Adverse changes to credit ratings:
Fitch, S&P and Moody’s downgraded long-term and short-term debt ratings
I believe BAC will be able to handle any possible credit downgrades.
Bond Rating of A2 by Moody’s or A by Standard & Poor's.
7) Double Dip Recession:
I believe a double dip recession is a low-probability event.
8) Credibility of Management:
Credibility of management is excellent and I don’t see any credibility issues with present management.
I am sure regulatory changes will have negative effects on the revenue but over time, BAC has good franchise value to overcome the changes.
Present management has been doing an excellent job in order to meet regulatory standards. I don’t see any risk from a regulations perspective.
10) Liquidity Crisis:
Short-term repo financing, OTC derivatives, off-balance-sheet activities, prime brokerage and loss of cash settlement privileges at a dealer's clearing bank accentuate a liquidity crisis if BAC loses confidence in the market.
BAC, with a strong deposit base, will be able to handle a liquidity crisis, although I believe a liquidity crisis is low probability event.
In the worst-case scenario, total loss for BAC over the next three to five years will be the sum of $35 billion (residential mortgage loss), $54.5 billion (home equity loan loss), $12 billion (credit cards and commercial loan loss), $48 billion (representation and warranties) and $10.5 billion (European exposure).
So the total loss in the worst-case scenario will be $160 billion over the next three to five years. With allowance for credit losses of $34 billion, deferred tax assets around $30 billion, excellent earning power of the franchises, and some asset sales, BAC will do fine even in the worst-case scenario.
When all the legacy issues are resolved, BAC will have earning power of $18 billion to $22 billion every year. With current market cap we can buy BAC at half the book value which is four to five times its future earning power.
When all the legacy issues are resolved, even if BAC sells at book value, return on investment will be 15 to 20 percent over next five to seven years.
Why is BAC stock selling at .4 percent of book value?
a) Many institutional investors look for short-term gains.
b) There is lot of negative talk and negative emotion towards banks.
c) People tend to exaggerate effects of near-term past events.
I am long on BAC and I invested 10% of my portfolio in BAC. I started my reasearch on BAC because many prominent value investors hold this stock.
2) Bank of America, Citi group, Wells Fargo, JP Morgan Chase 10-k reports
3) The Bank Credit Analysis Handbook – Jonathan Golin
5) How Big Banks Fail And What to Do about It – Darrel Duffie
6) Banking and Financial Institutions:A Guide for Directors,Investors and Borrowers --Benton E. Gup
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