Saturday, December 3, 2011

Bank of America & Europe

We'll I know it's been a while since my last post, I do intend on making up for lost time shortly.  When a guy goes away for a week (with no phone or email), it leave quite a bit of work when you return.  We'll I was poking around over at Corner of Berkshire and Fairfax today and posted this reply to a comment on Bank of America (BAC).  To save money and use the shotgun approach, I am re-posting here to save time. 

Just so everyone knows, and to repeat from my first post ever, I don't enjoy rehashing the latest news and current events.  I strive to provide original content, full of facts and written in an enjoyable way.  This post does discuss Europe which I have been trying to avoid since it's not original, but I believe contains some interesting facts and puts things into perspective.  Enjoy!

My reply...

Can you please provide sources for your numbers?  For instance that the big 5 banks have CDS exposure of $244 trillion?  I think you might be confusing CDS exposure to total notional derivatives at the big 5 banks.  For instance BAC has $68.2 trillion in total notional derivatives outstanding.  What is interesting is 86% of these are interest rate contracts.  Specifically, looking at the CDS exposure, they have written about $2 trillion in CDS and have also purchased $2 trillion in CDS contracts.  Actual net exposure is about $100 billion CDS written and $100 billion CDS purchased.  At the end of the day netting CDS assets from liabilities gives an asset of $5.6 billion down from $6.6 billion and the beginning of the year. 

Now the real question is who/what are the CDS contracts written on AND who/what are the CDS contracts purchased on?  If you know I would like to know.  When people talk about banks being black boxes this is exactly what they mean (or should mean). 

Many say banks are black boxes because of the removal of mark to market (FASB 157), which is not true.  Mark to market still applies unless the market is illiquid or non existent.  For BAC Level 3 assets (the ones marked to fantasy) are 2.9% of total assets and 4.8% of risk weighted assets (RWA). 

Ironically, these are the best among the large US banks, including WFC, JPM, C.  So when pundits toot their horn saying you can't believe the balance sheet, this is the part they are talking about.  This brings me to my next point. 

Many people claim that JPM has a rock solid balance sheet.  This includes newspapers and the nut jobs running around over at seeking alpha that either post OR comment out of ignorance.  Level 3 assets are 5.0% of total assets and 9.3% of risk weighted assets at JPM.  That is enough to drive a truck through.  They also have the largest notional amount of derivatives outstanding and the largest amount of trading assets.  If anyone says JPM has a rock solid balance sheet (including Jamie Dimon), are talking their own book or don't know the facts.  The only company with a rock solid balance sheet is Wells Fargo, the only one that didn't need TARP.   

Now I am long BAC.  The reason why I am long is because the numbers just say they are too cheap.  If they earned 1% on assets or 10% on equity that would be $22 billion profits vs a $55 billion market cap.  Even if the market cap doubled to $110 billion that still would only be 5 times average earnings.  The math isn't hard.  But i'll be honest; the reason why BAC is a crappy company is management.  How many screwups in the past year?  You can't even count them on all your fingers and all of your toes. 

Anyway getting back to the CDS stuff, it's not nearly as big as you think and if you have any details on who/what then that would be of value.  From what BAC has broke out on Europe in Q3 they have $1.5 billion in derivatives outstanding on Italian sovereign debt (likely CDS written) and have purchased $1.2 billion in CDS protection.  The net is about $300 million or not enough to worry about.  They also have some exposure Portugal and Spain in the tens of millions, but they are totally covered by CDS protection purchased. 

Just to put the European debt crisis in perspective, the US debt crisis was $15 trillion of bad mortgage loans against a $15 trillion dollar economy.  Huge.  If you add up all the sovereign debt of the PIIGS, it's $4 trillion at risk against a $15 trillion dollar economy (European union).  In my opinion, Italy and Spain won't default and they contribute $2.2 trillion and $0.9 trillion respectively to that $4 trillion total.  So the rough $1 trillion that's left isn't as much as the pundits make it out to be.  Now if the creditors accept a 50% haircut that further brings it down to $500 billion, something still very large but not unmanageable.  The real reason why Europe is a mess is because of the political structure and the inability to run a printing press to bail them out. 


Best Regards,

Kevin


Disclosure - Long WFC and BAC

5 comments:

  1. This post got me looking at the US banks again. I'm still avoiding BAC, as bad management can always find ways to destroy value, but WFC is almost a no brainer, and it should be a great investment assuming anything less than a deflationary collapse. Of course, having a position in FFH is a great hedge against such an outcome.

    -SR

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  2. The only reason to invest in the banking sector is because you believe that the central banks in the world are going to bail them out every time they run into insolvency issues. They are not only black books, which are impossible to determine the value of, but they are highly leveraged. I recommend this interview of Chris Martenson:

    http://www.economicnoise.com/2011/12/04/martenson-and-turk-on-the-financial-crisis/

    He says, by the way, that the fund managers invest publicly in the standard fare that they always have, but then ask him how to protect their own portfolios, at which point he recommends that they buy tangible assets.

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  3. Peter said, "The only reason to invest in the banking sector is because you believe that the central banks in the world are going to bail them out every time they run into insolvency issues"

    Where was the central bank to bail out Washington Mutual, Wachovia, and National City? You don't know what your talking about.

    As for Chris whoever he is. I beat to my own drum not the comments or recommendations of anyone else.

    Best Regards,
    Kevin

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  4. Hi Kevin:

    Wow, I totally forgot that Central Banks choose favorites: they choose who they are going to let go bankrupt and they choose who they are going to bail out. WAMU went down? Do you think that might be why my account was transferred to JP Morgan Chase?

    But if there is that much risk, then it seems to me that you shouldn't invest in Bank of America, because you don't know that Bernanke is going to give them a life line when the 53 trillion in derivatives go south.

    You seem to like Buffet. But not Martenson. How does that make you an independent drummer? You just choose to follow a different conductor.

    Personally, I think Martenson and a few others are right (esp. Zero Hedge) to call into question the over-leveraged, over-risked big banks. As I said, if you risk any money at all in them, you must have a firm belief that they will always have Bernanke's help. Otherwise, they are too risky.

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  5. Bank Of America's Debt Exchange And PIIGS CDS Exposure
    http://seekingalpha.com/article/305752-bank-of-america-s-debt-exchange-and-piigs-cds-exposure

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