Opinion

Felix Salmon

BofA chart of the day

By Felix Salmon
November 4, 2010

Jonathan Weil has a great column on Bank of America, noting that it’s trading at a price-to-book ratio of just 0.54. That’s not because it’s losing money, but rather because no one believes the bank’s numbers. And it’s easy to see why that might be, when BofA insists that its Countrywide goodwill — all $4.4 billion of it — remains unimpaired, even as the brand name has been dropped.

Bank of America releases a new number for its book value every quarter; here’s a graph that the fabulous Frank Tantillo put together showing how the ratio of BofA’s market cap to its book value each quarter.

Clearly there’s been a rebound from the worst days of the financial crisis, but back then there was no end in sight to BofA’s losses. Today, one would imagine that with a steep yield curve (banks love steep yield curves, since they mean that their core business of maturity transformation becomes very profitable) and too-big-to-fail status, BofA should be insanely profitable.

If a bank is profitable, and if it’s not lying about the value of its assets, then it should trade above book value. But BofA hasn’t come close to that level in over two years. Something is wrong, and Weil puts his finger on exactly what it is:

The only certainty is there is none, aside from the knowledge that Bank of America’s top executives have no idea what goes on inside the bowels of their company.

BofA isn’t just too big to fail, it’s also too big to manage. And the stock market is punishing it for that fact. Unless and until that price-to-book ratio goes back above 1, the market simply doesn’t trust what BofA is saying.

Comments
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I am no bank lover, but Jonathan Weil has never met a bank he liked and his analysis (and yours) is off the mark. Bank of America is not uniquely bad: 6 out of the 10 largest US banks currently trade below book value (including JPM — everyone’s favorite large cap) and the reason is not because book value is suspect or management doesn’t know what’s going on, but because ROEs are low. If you can’t earn your cost of capital, you deserve to trade at a discount to book. Simple as that.

Posted by NoNamesLeft | Report as abusive
 

But banks’ cost of funds is, like, zero!

Posted by FelixSalmon | Report as abusive
 

(1) I don’t trust their accounting.

(2) I don’t trust their management.

(3) I don’t trust their book to hold up in an inflationary environment.

(4) I’m suspicious of their ability to turn that book into profits in the current regulatory environment.

Other than that, BAC is a clear buy.

Posted by TFF | Report as abusive
 

Felix, banks require equity as well as deposits, and their cost of equity is (presumably) greater than zero.

It is also hard to find “safe” loans to make in an uncertain environment.

Posted by TFF | Report as abusive
 

“But banks’ cost of funds is, like, zero!”

But funding is not the same as capital, and bank capital is expensive; that is the meaning of low share prices. No matter how steep the curve, you profit by borrowing cheaply unless you can find a good credit to lend to. Good credits who want to borrow are hard to find.

Having said that … to say that book value is not suspect seems a stretch. Bank management may very well know what is going on, but that is an indictment, not praise. Banks are still carrying 2nd lien exposure at inflated values and their enthusiasm for foreclosure is due to a desire to continue this state of affairs. Otherwise they would take the more profitable short sales and write-downs.

Posted by Greycap | Report as abusive
 

” Banks are still carrying 2nd lien exposure at inflated values and their enthusiasm for foreclosure is due to a desire to continue this state of affairs. Otherwise they would take the more profitable short sales and write-downs.”

How does this sentence make any sense, given that foreclosures wipe out 2nd liens? You can’t simultaneously argue that the banks are trying to protect their 2nd-lien exposure and that they’re foreclosing enthusiastically.

Posted by wmartin1 | Report as abusive
 

No dispute on the generous marks at which most banks are carrying their assets, but the idea that banks will make money in steep yield curves with maturity transformation is just not supported by the evidence. Almost all banks, especially the larger ones hedge out their interest rate risk. BoA is one of the few banks that actually discloses its interest rate risk in great detail.

In a post while ago on this same topic http://www.macroresilience.com/2010/04/0 4/maturity-transformation-and-the-yield- curve/ , I looked specifically at the sensitivity of their income to interest rates (It’s the graphic in the middle – the same graphic can be found in each one of their quarterly investor presentations). For one, the impact of massive moves on their income is minimal compared to the size of their balance sheet. Moreover, they make money if rates go up and the curve flattens – this is exactly the opposite of the risk exposure they would have if they simply borrowed short and lent long unhedged.

Posted by macroresilience | Report as abusive
 

wmartin1, I would argue that the banks prefer writing down a few bad 2nd liens through foreclosure than losing a whole lot more in a wide-scale principal reduction program, even if principal reduction is the fastest and most efficient way to solve this crisis.

Posted by Stevensaysyes | Report as abusive
 

wmartin1, nobody gets wiped out until the house is sold. A foreclosed house can sit unsold indefinitely. On the other hand, although the 2nd lien can often extort something from a short sale or restructuring, everyone takes an immediate write-down.

Posted by Greycap | Report as abusive
 

“even if principal reduction is the fastest and most efficient way to solve this crisis.”

A broad based principal reduction program is by definition the LEAST efficent way to solve this crisis. The most efficent way to solve the crisis would be to somehow know exactly which people are willing and able to “stay and pay” and give them no help whatsoever. Call this group the people who get screwed.

Then look at all the people who could be incented to stay in pay if they just had to pay a little less (but still more than anyone else would pay for their house.) Write down their principal just a bit so that they would rather stay and pay than walk and default. Strip these people of any price appreciation up to the value of their principal write down plus interest compounded annually at the rate of their new modified loan. These people wouldn’t get screwed as badly as the first group but also would not totally make out like bandits because any price appreciation in their homes at this point would likely be forfited.

Group #3 are people who’s changed life circumstances preclude them any possiblity of staying in their McMansions bought with fraudently obtained financing. Those people get to walk away and forclosure. Those people get to move from Detroit or Las Vegas where unemployment exceeds 15% to places like Minneapolis where unemployment is half that. These people might get the best deal of the 3 groups assumming their new found freedom from the chains of an underwater home allow them to actually get re-employed. If they are not willing to get re-employed than any program to help this group is a transfer of wealth from the good apples to the bad apples. The people without the willingness and ability to pay can’t keep the homes that other people with the willingness and ability would like to have. This process is slow and ugly in the short term and the greatest generator of wealth and prosperity in the longterm… it’s called capitalizem.

Posted by y2kurtus | Report as abusive
 

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