The Third Pig

Excerpt from Brick Financial's January 2006 Client Letter:

...The BofA sell was a little different. It too faced the daunting condition of a nearly flat yield curve. It, like most other large banks, is likely to see its net interest margins get worse before they get better. The recent earnings miss is a symptom of this. Although the company’s management expects their acquisition of credit card issuer MBNA to begin adding to earnings as soon as 2007, we’re skeptical.

Not that we think MBNA is a questionable business. Just the opposite. We think it’s a fine business. It is more that we think the management of BofA, especially its CEO Ken Lewis, has an uncomfortably optimistic outlook (euphemism for “misleading”) no matter the conditions of the economic climate. An example of what we mean is when management consistently reports pro forma figures rather than the more conservative GAAP figures. Pro forma figures have many assumptions or hypothetical conditions built in which allows for an alternative view of the financial statements. But that’s just semantics. Usually companies use pro forma figures to hide all the bad stuff.

“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. [emphasis ours] 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!”

Evaluating the management of companies is essential to our investment process. We look for capable management. We look for management groups that treat their shareholders (and customers) with high regard. We need to feel like management is speaking with us candidly and honestly. We do not want management painting a rosy picture, were there really is none. We want management to “give it to us straight”. We just don’t get that feeling from the management of BofA...

Read the rest of the January 2006 Client Letter by clicking here.