Is Bank of America "Rotted to the Core"?
A major controversy has erupted in the blogosphere over the value of Bank of America's balance sheet, and whether the bank will be forced to raise capital in the near future.
At the center of the debate is my colleague Henry Blodget, who touched off a maelstrom Tuesday with a blog that concluded Bank of America might need to raise up to $200 billion in capital.
"The trouble is that the market doesn't believe Bank of America's assets are worth anything close to what Bank of America says they are worth," Henry writes, citing the following items other observers think should or will be subtracted from the bank's $222 billion of book value:
- $15-$20 billion in Increased mortgage-litigation reserves. Zero Hedge thinks BOFA is understating the liability for mortgage litigation costs by this amount. See explanation here.
- Some percentage of $80 billion of "second mortgages." Yves Smith thinks these should probably be written down by 60%, or $48 billion. You can pick your own number.
- Some percentage of $47 billion in commercial real estate loans.* The "extend and pretend" game in commercial real-estate is even more pronounced than in residential real estate. So as Yves Smith observes, there's almost no chance those loans are actually worth $47 billion. (UPDATE: Our original post said BOFA's CRE exposure was $182 billion, which was a number cited by Yves Smith. BOFA said this number was off "by a factor of 4." Yves has since rechecked the filings and realized that she made a mistake. I apologize for relaying it.)
- A healthy percentage of $78 billion of "goodwill." Bank of America built itself by acquisition. "Goodwill" is what's left over when management overpays for something. As Yves Smith observes, Bank of America's former CEO Ken Lewis loved overpaying for things. He overpaid for Countrywide, for example, which has since been written off to zero, and Merrill Lynch, which he could have had for free by waiting a couple more days.
- Untold amounts of exposure to collapsing European banks and sovereign debt.* Yves Smith says Bank of America says its European exposure is $17 billion. (UPDATE: Bank of America issued a statement clarifying that its "sovereign" exposure--to the debt of PIIGS countries--is $1.7 billion. The overall European exposure is $17 billion. But the big concern here is not just sovereign exposure--debt of countries--but bank exposure. Along with the associated derivatives.) Really? Has the firm not written any credit default swaps protecting customers in the event that European banks or countries go belly up? Might the firm have to post some cash "collateral" to satisfy these contracts? That's what Lehman had to do, after all. And that's what made Lehman go from "having plenty of capital" to being broke overnight.
"The market also doesn't believe that Bank of America has reserved anywhere near enough to pay the costs of litigation surrounding its mortgage behavior during the housing boom," for which it has already paid $13 billion in settlements, Henry added.
Bank of America's response was quick and ruthless: "Mr. Blodget is making 'exaggerated and unwarranted claims' which is what the SEC stated publicly when he was permanently banned from the securities industry in 2003," the bank declared.
Shoot the Messenger
The bank took umbrage with Henry's figures on its exposure to sovereign debt and commercial real estate (which were corrected from as noted above) as well other conclusions and the motivations of some of his sources. "The mortgage analysis was provided by a hedge fund that has acknowledged it will benefit if our stock price declines," BofA said. (For the record, Henry is long Bank of America stock and thus has no incentive to drive the shares lower, as some critics contend.)
Some bank analysts, including Dick Bove and Meredith Whitney have come to Bank of America's defense. "There's no reason for the bank to have to out and raise capital whatsoever," Bove told Bloomberg TV.
Meanwhile, JPMorgan upgraded BofA stock to neutral from underweight, and Bank of America shares were rallying sharply midday Wednesday, albeit from depressed levels. Bank of America, meanwhile, dismissed a rumor that it was in talks to be acquired by JPMorgan.
On the other hand, several high profile bloggers and financial writers such as Barry Ritholtz, Chris Whalen, Yves Smith, Michael "Mish" Shedlock and Zero Hedge have entered the fray in support of Henry's critique.
As Henry and I discuss in the accompanying clip, the whole Blodget and the Bloggers vs. Bank of America debate may make for a good Twitter-spat, but obscures the much bigger issue: Nobody really knows what's one the bank's balance sheet and BofA didn't take the opportunity to offer more clarity in its spirited defense yesterday.
Meanwhile, Bank of America shares have fallen nearly 50% in the past month and the price of insurance against default has surged to record levels.
"I'm sorry if BOA thinks the market is stupid," Henry says. "We went through this in 2008; all the banks said 'we're perfectly capitalized, we're in great shape'; three months later they were revealed to be rotted to the core. The concern is that's what's going on here."
For the record, I reached out to BofA's representatives for comment and will update the story if and when they respond. We've also extended an open invitation to CEO Brian Moynihan to appear on The Daily Ticker and address these and related issues.
Not one to shy away from controversy, let me weigh in with my thoughts. The comments you will read below are blunt and to the point, which is exactly my style of expressing myself.
First, and most importantly, I couldn't care less what Henry Blodget, Yves Smith, Tyler Durden, or any other frigging clueless analyst with no significant skin in the game thinks about Bank of America. I only pay attention to what elite funds are buying and selling. That's it, that's all. Everything else is just noise (doesn't mean these elite funds are always right or good market timers!)
I invite you to carefully go over the detailed institutional holdings of Bank of America (BAC) for Q2 2011. In particular, click on change in shares column and you'll see top funds like Wellington and Kingdon Capital increased their purchases in Q2 (click on image to enlarge):
If you then click on page 2, you'll notice another top fund Dodge & Cox, significantly increased its position in Bank of America. Also worth noting, two large Canadian pension funds, the Caisse and OMERS, significantly increased their position in Bank of America during Q2 (click on image to enlarge):
Here are some other elite funds that increased their BAC holdings: Citadel, Shumway Capital, Jabre Capital, Marathon Asset Management and SAC Capital (albeit, they didn't report a significant stake). I did however see Paulson & Co. decrease their holdings in Bank of America and Citigroup in Q2. Maverick Capital, another elite fund, significantly increased its holdings in Citigroup.
Second, and equally important, I'm growing increasingly weary of Tyler Durden and Yves Smith. I flat out don't trust either of them and think they have hidden agendas on their blogs where short sellers feed them a bunch of doom & gloom bullshit and their readers lap it up. In particular, I would like Tyler Durden of Zero Hedge and Yves Smith of Naked Capitalism to publicly state that they receive no financial support from hedge fund managers like George Soros (Naked Capitalism) or Eric Spott (Zero Hedge). Just read the dribble Tyler posted on this controversy and read the comments (I can't comment any longer because Tyler blocked my account. His way of silencing the sole bullish voice on Zero Hedge!).
I trust few in the blogosphere and will flat out tell you that I pretty much kill whatever I eat and will always publish the truth no matter who is funding me. If they don't like what I'm publishing, tough luck! No hedgies funding me, not even those who I recommended multi-million dollar investments (cheap bastards are collecting 2 & 20, gathering assets, selling beta as alpha to stupid pension funds). I bust my ass every day trading and blogging, stick my neck out and hardly anyone has given me a penny. Everyone wants a free lunch (my way of saying stop being cheap and donate to Pension Pulse!!!).
Finally, I am currently long JDSU and RIMM and remain neutral on Bank of America. I think it's way oversold and due for a nice bounce (it was up 11% on Wednesday), but financials are getting clobbered as leading economic indicators point to a double-dip recession (not convinced yet). Having said this, Bank of America and financials have a powerful ally in Fed Chairman Bernanke who basically gave them the green light over the next two years to borrow at zero percent, invest in Treasuries locking in spread, and then trade risk assets all around the world in search of yield. This allows big banks to make enormous trading revenues and shore up their weak balance sheets.
If you ask me, only fools would short Bank of America, Goldman Sachs, Citigroup or other financials in this environment. There will be more dips, but I'd be loading up on them. Below, watch a few clips on the controversy, and remember, even though I'm not always right, I have no hidden agenda and will always deliver the straight goods. No bullish or bearish screen savers on my computer and no big hedge fund managers backing me up (couldn't care less, don't need them). If you appreciate my work, please donate to my blog by clicking on the PayPal "DONATE" button under the pig at the top of the page. Thank you.
UPDATE: BAC shares are up 9.5% Thursday following the news that Warren Buffett's conglomerate Berkshire Hathaway will invest $5 billion in Bank of America. That's why he's the one of the best investors in the world because he knows a deal when he spots one and isn't afraid to put his money where his mouth is.
A buddy of mine, a broker, sent me this comment:
Of course, Buffet doesn't buy in open markets like you and I, he bought preferred shares. But he's not investing $5B because he thinks Bank of America will go bankrupt. If it goes lower, he'll probably increase his stake. It was a great stock to trade this week. Period. Nice 30%+ bounce. And according to Bloomberg, Buffet already made $ 1.3 billion on his first day.
If my memory is correct....
Warren Buffet made a big investment in Goldman Sachs around $115 per share back in 2008/2009 - during the days of the financial crisis. Stocks rallied big time on the news.
Then, the market got over the excitement and resumed its decline. GS finally bottomed around $55 before it was all over.Watching CNBC this morning, you'd think Buffet just saved the world again with his investment in BAC. I'm wondering if maybe he's a little early again.
As I stated, traders will likely sell the Fed's news tomorrow no matter what it is. We shall see. If they do, just keep buying the dips.