Big capital infusion needed at BAC
Posted by Jason Apollo Voss on May 6, 2009 in Blog | 2 commentsGood morning folks!
So the details of the first big stress test of the national banks that I posted about yesterday have been leaked to the public and they regard the U.S.’s biggest bank: Bank of America (ticker: BAC).
And wow (!) was the amount of additional capital needed by BAC large…$34 billion! Frankly, I found the number surprising. Why? Well for starters Bank of America’s market capitalization is about $70 billion. Market cap is calculated as the number of shares of stock of a business x the value per share of the common stock. The idea of market cap is that it is a quick way to see what the value of the shareholders’/owners’ interest is in a business. So the $34 billion of additional capital needed by BAC is almost 50% of the value of the company to owners ($34 / $70 = ~50%)!
So the Feds are saying that Bank of America needs to raise half as much equity capital as it already has and that is likely to be tough. Where does one go to find a spare $34 billion? Where does one go to find a spare $34 billion when the U.S. government just announced to the world that your institution is weak and needs more money? Hmmm. Double hmmm. It will be fascinating to see what BAC does to meet the shortfall.
Preliminarily they have revealed some potential sources of capital raising: selling its First Republic banking unit; selling its money manager Columbia Management; selling the shares of China Construction Bank that it owns; and selling new shares of common stock to the public if the value of BAC’s stock rises. However, all of this is expected to leave it with a sizable shortfall. The last option that BAC has is that the U.S. government, as part of its bailout package for the bank, has been issued preferred shares of stock in BAC. The U.S. has the option of converting those preferred shares to common shares and that would satisfy the capital increase needed to adhere to the stress test standards. Buuuuut the problem is that if the latter two options are chosen by Bank of America they will substantially dilute existing shareholders.
What is dilution? Dilution is having a fixed sized pie at the party, but all of a sudden 50% more guests show up, and now everyone’s piece of the pie is significantly reduced. Ugh!
It will be interesting to see what the financial market response is to this BAC news. If the financial markets are up then presumably the potential bad news of the stress test capital requirements is already baked into share prices. If the markets are down then they were not. And if they were not baked into the expectations of the market: watch out! It should be a day worth paying attention to the response.
Jason
Hello
I am a foreign investor of the US markets and am keen to buy BAC, Citigroup and AIG shares. In recent days, there appears to be a rise in each of the share prices of these financial institutions. Considering that there is the up and coming stress tests, is it worthwhile taking a plunge on each of these, say $5,000 US each on each of the above shares, or should I wait.
Curious….
Dave
Sydney, NSW
Australia
Hello Dave,
Thanks for the comment. In general, I steer clear of giving investment advice regarding specific companies, preferring to comment about the financial markets in general. The reason is twofold
(1) I no longer get paid to monitor the tens of thousands of publicly traded firms worldwide and thus do not dedicate the time to do it.
(2) One of the intentions of the blog is to empower individual investors to make their own choices.
That said, let me see what I can do for you. If you have read past blog postings you will know that I have been saying for many months now that there is an unprecedented opportunity to own outstanding businesses right now due to the across the board depressed valuations.
Well one of the companies that I have been buying shares in is Bank of America. Whether you decide to buy along with me is up to you.
The firm that I used to work for was one of the largest shareholders of both Citigroup (ticker: C) and AIG (ticker: AIG). I consider AIG to be one of the biggest mistakes of my investment career. The problem was that I always felt that their corporate culture was enormously arrogant. When management is arrogant it means that shareholders’ concerns come second to management concerns. In the long run, in my opinion, that means you are going to lose money. That said, AIG is still a remarkable firm and the only insurance company in the world with a truly global platform. I have been looking at AIG but have not purchased shares. In my world, only a definitive “yes” results in a buy order. “Maybes” result in me saying “no” to buying an interest.
Regarding Citigroup. This is also a somewhat compelling story. Citi has a truly global platform as well. However, my own personal belief is that Citi is practically unmanageable as a business. It is so damned big it is hard to imagine how it could be managed well. In comparison to AIG, Citi is not even a “maybe” in my book.
As for your interest in buying shares in these businesses. You should ask yourself a couple of questions:
(1) What is your interest in becoming an owner of these businesses? In other words, is it to make a quick bit of money? Is it to take advantage of depressed prices? Or, most importantly, is it because you believe in the long-term prospects of the business and want to buy into a great business at a great price?
(2) What is your investment time horizon? Unfortunately, you have missed one of the biggest rallies in U.S. financial market history over the last 6 weeks. If your interest was the quick return, it is unlikely that you will see that kind of return in such a short amount of time again. To invest now you likely need to be in it for the long haul.
As for trying to game the results of the stress tests…see the most recent blog posting.
Thanks for your question and your interest!
Jason