Die CFC- and BoA "Lies, Damn Lies"
—and Ken Lewis and Al De Molina
Uh-oh, BofA executives are moving their lips again!
Thursday, January 26, 2006
Thomas K. Brown
bankstocks.com
tbrown@bankstocks.com
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That was some earnings miss Bank of America came up with on Monday. The company reported fourth quarter results of 94 cents per share, down from 98 cents a year ago and against a consensus estimate of $1.04. On the one hand, BofA can perhaps be forgiven for turning in such low-octane results: other megabanks, such as Citi and J.P. Morgan Chase, didn’t quite bowl investors over with their fourth quarter numbers, either. It’s hard to see how BofA could have dodged the same issues (the flat yield curve and the lingering effects of the new bankruptcy law, in particular) that dogged those other two.
But if you listened to what BofA’s management had to say on the company’s quarterly conference call, it’s hard to not conclude that these guys have yet to give up their habit of blowing smoke in their investors’ faces. It’s as if they don’t know how to bring themselves to not mislead Wall Street! Here are some particularly egregious examples of the obfuscations, evasions, and misstatements that Ken Lewis and his crew tossed out Monday morning:
Ken Lewis: “Over the past two years, total revenue is up 13% on expenses were up 3%, excluding merger with provision up 4%, and securities gains being relatively flat, EPS rose 31%.”
My take: This is what we refer to around here as “Charlotte math.” By the lights of my Bloomberg, BofA earned $3.57 per share in 2003, $3.86 in 2004, and $4.15 in the year just ended. So over the past two years, earnings have risen by 16%, half the 31% growth that Lewis alleges. In response to my inquiry, a company spokesman emailed to say that the 2003 EPS Lewis was referring to are the pro forma numbers the company filed at the time of the Fleet deal in 2004. Which is to say, Lewis’s statement is nonsense. The fact is that investors don’t have a claim on retrospective pro forma numbers, nor do those numbers help build economic value over time. What matters are actual, here-and-now GAAP numbers. Lewis knows that, of course, but he threw out those phony numbers to make his performance look better than it really is. That’s our Ken!
CFO Al De Molina: “So long as the growth rate implied in our stock price, which is below 4% today, remains lower than our view, our bias is to be using our available excess capital to buy Bank of America shares. Given that our expectation of 10% long-term growth in earnings implies a stock price of over $75, you can expect us to be an active buyer of our shares . . .”
Me: If you think BofA is buying back stock because it thinks the stock is a compelling investment opportunity, and wants to boost shareholder value, you need to have your medication changed, in my view. Yes, BofA will buy back tons of stock this year, for the simple reason that it needs to offset the huge dilution that would otherwise come about as the company lards up management with huge grants of restricted stock and stock options. If you doubt it, look at recent history: from 1996 through 2003, BofA repurchased 659 million shares. It bought in stock rain or shine, when it was up, and when it was down. And yet over that period, BofA’s share count fell by just 311 million. (Post-2003, share count ballooned, of course, as a result of the Fleet and MBNA acquisitions.) Guess who was the big beneficiary of all those buybacks? Hint: not shareholders. P.S.: My guess is that the market’s estimation of 4% EPS growth for BofA is a lot more accurate than the company’s guidance of 10% growth. P.P.S: If Al De Molina really thinks an expected 10% grower like BofA should trade at 17 times earnings, as he implies, he should tell Ken Lewis to get BofA out of the lending business altogether and put the company’s capital to use by buying shares of just about every publicly traded bank he can find.
De Molina: “In July, we told you that MBNA would be 1% dilutive in 2006. We now think that the addition of MBNA will be neutral to earnings in 2006, excluding merger charges. . . . We feel better about the long-term trajectory. However, in 2006 standalone earnings for MBNA will be compressed more than expected due to short term rates.”
Me: If I were a Marxist, I’d say that the company has succeeded here in highlighting its own internal contradictions. On one hand, MBNA is now supposed to be less dilutive to BofA’s results than the company originally expected. Fair enough. But on the other, the company also admits MBNA’s business is in worse shape now than it was when the deal was announced. The margin squeeze from the flat yield curve has been more severe than expected, and the company’s customer base has been thinned by last year’s bankruptcy spike. And yet the deal is going to be less dilutive than first projected? Hello! The most likely ways that this can be are that either a) BofA will stash more ongoing operating expenses into its merger-related charges than it’s let on, in order to artificially prop up MBNA’s results for the next few quarters, or b) legacy BofA results will be so bad that the MBNA numbers will look sparkling by comparison. Either way, the outlook for the MBNA acquisition is worse than management is letting on, I believe.
De Molina: “Our success story in [the credit card] business stems from our ability to sell cards through our stores. Sales of credit cards in the stores were up 38% in 2005 versus 2004.”
Me: If any statistic from the call caused the hair on the back of my neck to stand up, it’s this one. Fact: bank branches are to adverse selection in credit card lending what college fraternity houses are to empty beer bottles. It’s not hard to understand why, either. The likeliest reason an individual applies for a credit card via a bank branch, after all, is that he’s such a bad credit risk that lenders know not to send him any direct-mail solicitations. And branch-originated card sales at BofA rose 38% last year? Wonderful. Alternatively, the company may simply be jamming credit cards down the throats of its existing checking account customers—in which case it’s highly likely the cards will rarely be used. So expenses go up with no corresponding rise in revenues. Whether management will admit it or not, the jump in branch-based originations is likely a bad thing, not a good thing.
Lewis: “I do, in fact, think this could be a period of time very similar to that 1998 to 2003 time where we just executed and there weren’t any major acquisitions. If something changed, it would be, it is not in my mind or I cannot see it at the moment.”
Me: Yes, Ken, if you say so. “That 1998 to 2003 time,” recall, was a sort of Golden Age for BofA shareholders that occurred after the BofA-NationsBank hookup, when the company said it had sworn off deals once and for all and would henceforth spend its energy focusing improving customer service and operations. For awhile, shareholders even benefited! Earnings growth and BofA’s valuation ballooned; the stock rose over 70% from its 2000 lows until mid-October, 2003. Then—kerpow!—the company blindsided investors with the Fleet acquisition in 2003 followed by--double kerpow!—the MBNA deal last year. Sure enough, BofA has lagged the S&P ever since the Fleet deal was announced. I scarcely need to add that, if it made no sense to believe BofA’s no-deals promises then, it makes even less sense to believe them now.
I could go on and on, but I’ve run out of blood pressure pills. The fact of the matter is that, in my view, these guys are constitutionally incapable of being straight with shareholders. (I’m going to try to change that at this year’s annual meeting.) They seem to have a pathological need to mislead. Heaven help them—and heaven help the poor souls who own shares in the company they run.
What do you think? Let me know!
/TKB/
The author is a Manager of a hedge fund and co-founder of bankstocks.com. His fund often buys and sells securities that are the subject of his articles, both before and after the articles are posted. Under no circumstances does this article represent a recommendation to buy or sell stocks. This article is intended to provide insight into the financial services industry and is not a solicitation of any kind. Neither the author nor bankstocks.com can provide investment advice or respond to individual requests for recommendations. However, we encourage your feedback and welcome your comments on any of the articles on this site. Neither the author nor bankstocks.com has undertaken any responsibility to update any portion of this article in response to events which may transpire subsequent to its original publication date.
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