Courtesy of Karl Denninger of The Market Ticker
In one of the most-ridiculous moves today, we have BAC, which is up some 3% this morning on the following news:
Bank of America Corp. (BAC), the biggest U.S. bank, agreed to pay $8.5 billion to resolve claims over soured mortgages after bondholders including BlackRock Inc. (BLK) demanded refunds. The company rose as much as 6.7 percent in New York trading.
The settlement will contribute to a second-quarter loss of $8.6 billion to $9.1 billion, or 88 cents to 93 cents a share, the Charlotte, North Carolina-based bank said today in a statement.
That, incidentally, is because the company has settled at a monstrous multiple to what it told the market were required reserves against these risks in the last quarterly report. Investors appear to be cheering this "settlement" but I have to wonder if they’re nuts.
Representations and warranties provision was $1.0 billion in the first quarter of 2011, compared to $526 million in the first quarter of 2010 and $4.1 billion in the fourth quarter of 2010. More than half of the $1.0 billion provision is attributable to the GSEs and the balance is primarily related to additional experience with a monoline. The additional provision with respect to the GSEs is due to higher estimated repurchase rates based on higher than expected claims from the GSEs during the first quarter of 2011 as well as HPI deterioration
In other words, there was effectively zero reserved against this settlement; it all went to the bottom line immediately. This is what the firm said in that quarterly report about their expectations for this risk:
Although the Corporation’s evaluation of these factors results in lowering the estimated range of possible loss for non-GSE representations and warranties, any adverse developments in contractual interpretations of causation or level of representations, or the presentation threshold, could each have a significant impact on future provisions and the estimate of range of possible loss.
No kidding?
This settlement only involves the specific MBS bondholders in question. Second, notice that they’re setting aside another $5.5 billion in reserves for litigation and settlement expenses with other parties. Given the firm’s history of being a "bit optimistic" in terms of their exposure on this issue, is this anywhere near enough?
Consider that this reserve plus payment is something like 12% of the firm’s market cap and you start to see the potential for trouble. Yes, the forward P/E is 6.5 and the PEG ratio on 5 year expectations is 1.24, but the question becomes exactly what is the enterprise value on a forward basis?
Hell if I know.
What I do know is that the TTM Revenue is listed as $82.6 billion, which means they’re tossing over the transom 17% of ttm revenues – in theory. If this is all there is, then that might be the "kitchen sink." On the other hand if this turns out to be yet another optimistic assumption this firm is in trouble – perhaps very big trouble – on a forward basis.
Bove thinks the bank is massively undervalued in the market. I think the chart looks like hell; it broke the previous low, and while it does appear to have stabilized for now it is often true that these sorts of charts presage something much worse coming around the corner, especially when you’re dealing with a financial company that has "entanglements" that are very difficult to analyze cleanly and form an informed opinion on their forward business prospects – especially when we get this sort of "surprise" from the company.
I’m staying away; I don’t short $10 stocks, but I sure as hell don’t buy companies that tell me they have a reserve of $X (tiny) for some risk and then pop up with an actual liability and an increased reserve of $Y, where $Y is a ridiculous multiple of what $X was. That tells me one of two things: Either management is dishonest or worse, they don’t know what their exposure to particular identified issues actually is.
