Late yesterday, Bank of America announced that it would be paying back the full $45 billion bailout it received from the government. It's doing so by using $26.2 billion in cash it has lying around (so that's why it hasn't been lending!) and selling $18.8 billion in an equity offering. This move surprised many, including me. I didn't think BOA was anywhere near healthy enough to pay such a huge sum back at this time. In fact, I remain unconvinced.
About a month ago, I wrote about how Wells Fargo was struggling with whether or not to pay back its $25 billion in bailout money. Like BOA, Wells has some cash on hand and could raise equity too. But unlike BOA, it was uncomfortable with paying back the government through these means for two reasons: it didn't want its Tier 1 capital ratio to fall too low, and it didn't want to anger shareholders by diluting its equity. Paying back the bailout by using cash and selling new shares has these effects.
Apparently Bank of America isn't worried about these issues. I find that a little bit surprising. But according to an article about the payout from thestreet.com, its capital cushion will be just fine:
After the stock offering and some other capital moves, Bank of America's Tier 1 capital ratio will stand at 11%, and Tier 1 common ratio will stand at 8.5% -- stronger metrics than Wells Fargo, JPMorgan Chase or U.S. Bancorp.
Only Citigroup has higher capital ratios, due to a huge preferred-to-common conversion, but given the government's large ownership stake and Citi's long path to reorganization, few expect it to repay TARP in the same manner.
Those capital ratios sounds pretty good, especially compared to the competitors mentioned. But Bank of America has a different balance sheet than those others -- it may still have to stomach losses from its portfolios associated with its Merrill Lynch and Countrywide acquisitions. The question is whether its capital cushion will remain high enough to sustain further losses. Since foreclosures continue to mount and big commercial real estate losses are expected, I'm not so sure.
Then there's the shareholder dilution. Here's what the article quoted above says about that:
Bank of America's offering will dilute existing common stock investors by roughly 10% and requires shareholder approval to raise the amount of outstanding shares above its current 10 billion level. The sheer size of the bank's float may provide attractive supply-and-demand fundamentals for investors looking to get a piece of Bank of America at a greater discount. However, given the positive news, its stock was up 3.2% in premarket action at $16.15 and rose in European trading as well.
The stock market never ceases to amaze me. Bank of America isn't any different this week than it was last week. Instead, it's diluting its equity by 10%. But the stock goes up. Here's why:
"Repaying the TARP is a clear positive for Bank of America shares, as it removes the overhang caused by uncertainty surrounding government intervention," FBR analyst Paul Miller said in a note Thursday morning, upgrading Bank of America stock to overweight.
Yes, it's great to be out from under Uncle Sam's thumb. But paying back the TARP will result in the bank sacrificing some of its capital cushion, creating a new uncertainty of whether or not it will be able to sustain future losses if they turn out to be large. If I were a BOA investor, I would not treat this news as purely positive.
If the economy takes a turn for the worse, this could cause the BOA go back to the Treasury, hat in hand. That's clearly a worst-case scenario. I'd love to see what loss assumptions its risk management division considered to determine how likely that is to happen. Given its residential mortgage, consumer credit, commercial loan and toxic securities exposures, such a scenario may be within the realm of possibility. But hey, at least they'll now be able to pay their new CEO well and fire back up their corporate jets.