Investment conclusion: We are reducing agency reps/warranties loss estimates by $1.2b to $10.4b given today’s actions and BAC’s commentary that it’s 70-75% of the way thru GSE claims. Reduced loss est is accretive to eps by 8c/share and worth ~80c to the stock price, which is what we got today with BAC’s 85c uptick.
What the market is not pricing in? Additional upside if reserves are too high against future agency r/w losses. We est agency reserves are ~$1B too high, worth ~6c/share in eps or about 65c to the stock. We model remaining agency loss estimates of $3.1b and estimate that BAC is carrying $4.1B in agency reserves. We do not model reserve bleed, but rather assume it could be used to help fund a more severe bear case private label reps and warranties losses than we are estimating.
Implications for non-agency r/w: We believe our reps and warranty estimate on non-agency exposures is conservative, and today’s announcement supports that view. Clearly, non-agency r/w exposure is very different from agency r/w exposures. However, our non-agency r/w loss estimates of $9.2B ($10.2B including our est excess reserve above) is roughly double the implied 1% loss against FRE’s unpaid principal balance (upb). This is likely too high given lower probability of successful putback.
What does BAC’s settlement suggest for lc bank universe? Implies agency loss severities decline by 14% or $4.4b for lc banks including reduced r/w losses of $1b for WFC, $840m for JPM and $600m for Citi, worth ~$1.35, $1.40, and 13c to the shares respectively.
Investment thesis: We are OW BAC as we expect falling credit losses, stabilizing PPoP, rising dividends and higher EPS and BVPS. At 0.7x PB and 1.1x PTB with growing earnings, BAC is cheap, in our view. Fundamental catalysts of stabilizing NIM, improving loan growth, and rising divi are coalescing around 2q-3q11 with credit improvements continuing throughout 2011+.