The Media and Bank of America

As I continue to dig deeper into $BAC, I am struck by something. The coverage of it is eerily similar to the same type of superficial skim the surface without actually doing work on it “reporting” that drove me crazy during the General Growth Properties $GGP saga. If you remember back then they were first saying shareholders would be left penniless then told shareholders to take a $9 offer from Simon Properties because “it was the best offer they would ever see”? We should note here that only months later $SPG offered twice that.

It boils down to “everyone thinks this so we will force every piece of news through that filter, no matter if it is accurate or not”.  It does make sense. It isn’t possible for a reporter who has to write 2-3 pieces a day to do the work necessary to break down  a $BAC or $GGP, they do not have the time. So, what do they do? Call for opinion and regurgitate the “group think”

So, here is the latest. I’ll break it down…

From Marketwatch

For Buffett’s legion of copycats, there is an addendum: “… and unless your name is Warren Buffett, even if you have money, you might not make money at all.”

That’s the reality facing investors after Buffett shocked Wall Street on Friday by announcing a $5 billion investment through Berkshire Hathaway Inc. BRK.A -1.24% BRK.B -0.80% in star-crossed Bank of America Corp. BAC -1.25% .

Simply put, this is a great deal for Warren Buffett. For everyone else, it’s probably a loser.

Yes, it is a great deal for Buffett. Being able to write a $5B check on any given morning IMO should enable you to get a nice deal. It would be worth noting here that Buffett ONLY got a “great deal” on the equity kicker on it. On the preferred, he paid a premium only getting 6% vs the 9% yield $BAC preferred shares were paying on the open market at the time. What does that mean? Buffett clearly thinks $BAC shares have much more upside. More on this later as the 6% $BAC is paying is a reoccurring theme in the article.

Two big reasons stand out. As many have noted, Buffett’s investment is a sweetheart deal aimed at giving B. of A. a much-needed lift through both a cash infusion and the cachet of having Warren Buffett as a big investor. He may end up owning as much as 6.5% of the Charlotte, N.C.–based bank.

Secondly, and more importantly, nothing has changed at B. of A. It’s still one of those “too big to fail” institutions that the government must support. So, even though it’s added some short-term capital — a drop in the bucket of what the bank actually needs — the deal will actually end up hurting shareholders by cutting into profits (if the bank actually makes some).

Indeed, Buffett’s deal actually makes things worse by creating a new cost.

Oh boy….1st paragraph, all good. Second is just a mess. A “drop in the bucket to what the bank actually needs”. Really? According to who? Where is the math? Or are we just regurgitating talking points? This is what I mean. This is the same crap we saw in the GGP Chapter 11, “shareholders are wiped out or only receive pennies on the dollar when a company files Chapter 11”. It is “conventional wisdom” which is a translation for “this is what I heard and no, I have not even remotely looked into it”. Hurting shareholders with interest payments. I’ll let Mr. Hempton answer this. His diessection of the deal shows how the Buffett deal and the low coupon will most likely lower $BAC lending costs when it rolls over some $100B in debt over the next two year saving the bank some $1.4B. So….paying $300M interest and saving $1.4B is bad for shareholders…….how?

Now for the “if it actually makes any (profits)” comment. Now we need to talk about actual profits vs non cash charges. See $BAC actually MAKES ~$36B a year in pre-tax/provision profits. This is lost on those who don’t do the work on it. All the write-offs many harp on, come out of those cash profits creating a “paper loss” but having no effect on the banks actual cash flow/cash profitability.

And yet, many investors are now willing to pay a premium for the privilege of forking over their money to Buffett. The bank’s stock jumped 24% in the first hour of trading following the announcement. It’s trading even higher after the bank announced Monday it was selling its stake in a Chinese bank.

The only thing surprising about this rush to slaughter is that Buffett has played this game before. His investments in bailout babies General Electric Co. GE -0.88% and Goldman Sachs Group Inc. GE -0.88% have played out terribly for mini-Buffetts who love to follow the oracle.

For instance, those who purchased GE when Buffett made his $3 billion investment in 2008 bought the stock at about $24. It’s trading close to $15.50 today.

Goldman investors have been pounded the same way. Buffett bought his preferred stake when the stock was at $115, about four bucks a share more than its recent price.

Meanwhile, while Buffett collected his special dividends — 10% annually on both holdings — investors in common stock were getting anywhere from 1% to 5%. GE investors had to cringe when the company cut its dividend by two-thirds less than six months after Buffett’s investment.

Goldman paid off its Berkshire investment this year, but it cost shareholders more than $1.7 billion — two years of dividends and a special payoff bonus of $500 million. GE, likewise, has coughed up $1 billion in dividends.

Did you know that if you roll around in horse shit for 15 minutes, your chances of getting a date with that cute girl you like are diminshed greatly? That comment has about as much to do with $BAC as whatever happened to $GS and $GE investments. Are they the same company? Are their fates intertwined somehow other than operating in the same economy? Does the same management run all three? Do they have the same Board of Directors? Why not point out Buffett took a worse deal on the preferred shares in the $BAC deal in return for a better equity deal than in the other two? THAT is the only realistic comparison worth making. Three different companies are going to have three different operating results, saying because $GS has not performed well means $BAC won’t makes zero sense. It should be pointed out (and hasn’t) that in this deal Buffett, rather than the safety of a 10% yield (or 9% at then market rates) Warren took less to get more common. I would think that would be a clue as to his view of what his equity investment will return over time. Right? I mean if $BAC was desperate for cash, doesn’t common sense tell us if we actually stopped to think about it Warren would have got a premium for the preferred, not paid one?

That’s why the rush into B. of A. stock is so maddening. Its terms are much like those investments. The bank will pay 6%, or about $300 million annually, for the privilege. Buffett can buy another $5 billion during the next 10 years at $7.14, less than the stock is trading for after the announcement.

Again (not to be redundant but this point is harped on incessantly in the article, see above for the interest math) terms are similar but place Buffett’s upside more on the equity here. Yes, Buffett can buy more at less that post announcement prices but it was more than pre-announcement.

None of this, of course, has anything to do with Bank of America’s fundamentals. The bank is being dragged down mostly through the legacy mortgage problems of Countrywide Financial and Merrill Lynch, which it bought in 2008. The bank paid $8 billion to settle claims related to bad mortgages last quarter.

B. of A. has lost nearly $14 billion since the start of 2009, and, despite the protests of its chief executive, Brian Moynihan, the bank will have to turn to more Buffett-like infusions if it hopes to meet the stronger capital standards demanded by regulators.

Yes, on Countrywide, an utter disaster. Ken Lewis ought to be in prison for it (not really, figurative, stupidity is not a crime). But, why will they have to turn to more infusions or is this another “I don’t really know but that is what everyone says” type thing? For this we go the the China Construction Bank sale yesterday. Here is why that was a good deal. As $BAC owned more than 10% of the banks, it actually lowered $BAC’s capital ratios because owning >10% of another financial institution is not viewed under Basel as a safe asset (concentration and correlation risk). So, by selling the stake to 5%, they in one fell swoop raised cash AND raised their capital levels in excess of the cash raised vs the subtraction of the asset raised capital levels. In fact, selling this asset will add ~.2% to the company’s Tier One Ratios under Basel III. Again, if we are talking about the banks “fundamentals”, we have to look at its core earnings power of ~$36B annually. Add that to the $37B they have in reserves and over the next two years, the company will have ~$110B to pay claims without raising another cent from a Buffett like deal. I have yet to see that number acknowledged anywhere.

Now, they will also continue to raise $$ by selling non-core assets (this is actually good) and that will raise that cushion, but for now, we will leave it as it (they have another $9B-$10B coming from credit card and RE sales soon not included in the above #’s).

Confidence in Moynihan among investors is weak, mostly because of his tendency to talk tough and then back down. Even in his talks with Buffett, Moynihan reportedly balked at first, telling Buffett that B. of A. didn’t need additional capital.

Much of this risk was built into a stock price that was hovering at or below $7 a share. Now that Buffett has entered the fray, there’s a 20% premium for a bank taking on $300 million in additional costs and Buffett’s right to undercut shareholders by buying more B. of A. at a discount.

This isn’t to slam Buffett, who has made another great deal with a bank that has an implicit government guarantee.

But for those who rush into the stock — which has just added another hefty charge, and given the track record — what’s the pleasure in being a follower?

That’s not following. That’s masochism.

Moynihan. Yes, confidence is weak, no disagreement there. I’m not sure I would call it “backing down” though. I think he is being very pragmatic. Talk tough in public to set the negotiating terms for settlement, then, when you get a good offer you take it. Because you talked tough, the folks on the other side of the table feel as though they have one and you have settled for a fraction of what your potential liability was. Moynihan had a reputation as a shrewd negotiator from his days at Fleet, not sure why people think now he has lost that ability. Could be this has been his style all along, only difference now is that it is being played out in front of everyone which makes it ripe for criticism at every turn.

I don’t know him personally/professionally, but seeing the settlements he has struck for the bank and the potential liabilities he has extinguished, I am of the opinion people aren’t seeing the big picture with him. I also think him saying they did not need to raise outside capital only weeks before taking the Buffett money was unfortunate. But, the more I look at the Buffett deal and the ancillary effects it will have, the more I come to the conclusion he would have been crazy not to take it. We don’t know but it is possible when he balked at the deal he then got better terms from Buffett. Everyone is of the assumption Buffett gave him a take it or leave it offer. It is just a likely Buffett, when he called (it was Buffett who initiated the deal) and offered, Moynihan countered and got better terms from Warren. We may never know but I do find the widespread assumption interesting.

The final line about “masochism” is the reason for the tone of my post here. Especially when the article is riddled with questionable/unsubstantiated claims and seems to have a lack of a basic understanding of the bank’s true situation (this is stunningly so when it comes to the “losing money” claims).

Ill leave you with a final thought regarding $BAC’s residential division. If you segment that into two departments, loans written 2005-07 (most Countrywide) and post 2007 you get two different results. The post are highly profitable (reasonable underwriting standards) and Countrywide’s are a mess. As those Countrywide loans are worked off (paid off, written off etc) the results from the post loans take over. When this division simply breaks even (it eventually will). Assuming no other improvement anywhere in the bank, $BAC earns $3 a share. Slap a 10X multiple on that and we have a $30 stock. Now, do we think maybe Warren, whose Berkshire owns the largest real estate brokerage in America (HomeServices) might be looking at that and that might be the reason he was happy to get more equity and less interest on his preferred?

Now, when will the residential division break even? If the stock goes from $7 to $30 or more…does it matter if it takes 1 year or 3?

Now onto todays other headlines: FDIC OBJECTS TO $BAC SETTLEMENT……. scary, right?

What did the FDIC say?

Andrew Gray, an FDIC spokesman, said in an e-mail that the FDIC generally doesn’t comment on pending litigation.

“This filing is simply a formal notice to preserve our right to make claims as a part of the settlement and seeks additional information to evaluate those potential claims,”  he said. “It is not an evaluation or opinion on the settlement itself.”

In order to be included they have to file “objection” to what was in front of the Judge. There is nothing called “we want in on this” filing in the legal system. They are saying they want a piece of that pie, not that the pie sucks…..read past the headline people…