IFR Editor-at-large Keith Mullin
WARREN BUFFETT’S INJECTION of US$5bn will not stop the rot at Bank of America. If anything, it proves that the bank’s naysayers were right to be wary.
In the aftermath of the news, dealers aggressively marked BofA’s CDS levels tighter, and the stock leapt from US$6.99 at Wednesday’s close to an intra-day high of US$8.80 on Thursday. But the shares then slid all the way back down to close at US$7.65. Even at that momentary intra-day high, the stock was still down 38% so far this year and 82% off the long-term high of October 2007. Hardly inspiring.
Frankly I expected a bit more enthusiasm, but then again, given the extent of the bank’s longer-term issues, perhaps my expectations were overdone. Chief executive Brian Moynihan still has a lot of work to do to avoid the slow grind to ignominy. I think the Buffett episode actually undermines Moynihan and makes him look a bit – well if not a bit of a fool, then certainly desperate.
I can’t imagine that existing shareholders are happy that an interloper has come in through the back door and got the better of them on price
This is, after all, the man who said publicly that the bank didn’t need to access capital markets, and that he would get the bank up to higher capital adequacy levels and stabilise the ship via a combination of retained earnings (tough in a potentially recessionary environment), disposal of risk-weighted assets (US$150bn or so), lay-offs, and the sale of non-core businesses.
NOT ONLY HAS Moynihan been forced to take in new capital, he clearly gave the impression that his only option was to go cap in hand to Buffett and accept a very expensive deal: cumulative prefs with a 6% dividend plus a ton of discounted warrants. And he can only get out on payment of a chunky exit premium that’ll cost him US$250m. I reckon that’s pretty embarrassing. I can’t imagine that existing shareholders are happy that an interloper has come in through the back door and got the better of them on price.
The sale of Merrill Lynch had been touted. This could be a substantial money-spinner, but I suspect selling such a trophy asset would be a wrench and would send the bank back to oblivion in international investment banking, capital markets and trading.
The broader point here is that Buffett’s money doesn’t go anywhere near to solving the bank’s problems. It’s provided a level of stability that could be pretty short-term in nature. It will facilitate what is a still-inevitable call on the public equity capital markets, and will probably put counterparties’ minds a little more at ease for a while. But that’s all.
Prior to Moynihan’s desperation deal with Buffett, the talk about Bank of America had been almost wholly negative. I’d laid out two scenarios that summarised the chatter:
Scenario A: Bank of America is technically insolvent, given massive delinquent exposures and significant anomalies in its asset valuations. It is forced into a sizeable equity offering and offloads Merrill Lynch, along with a swathe of other assets, at fire-sale prices to raise capital to meet regulatory capital requirements.
Scenario B: Bank of America merges with JP Morgan. Concerns about the bank, which remain unresolved regardless of Buffett’s move, revolve around asset quality and valuation, potential future write-offs, the Countrywide MBS settlement, and talk of those shares succumbing to a death-spiral if management doesn’t act quickly.
I never got the impression that anyone really thought Bank of America could go bust, but people are openly talking about insolvency, bankruptcy or a second government bailout. Gossip that the bank was in merger negotiations with JP Morgan did the rounds but was swiftly discounted as being fanciful.
Given the huge overlap between BofA and JPM, I never thought it made a lot of sense, and to be sure, such talk had all the hallmarks of late-summer fabrication concocted to raise the temperature. It’s interesting to note, however, that BofA’s market cap of US$77.5bn at Thursday’s close is little more than half that of JP Morgan.
THE TEMPERATURE WAS already rising on Tuesday when Henry Blodget, the storied former Merrill Lynch analyst-turned-blogger at Business Insider, suggested in a blog that BofA could be forced to raise between US$100bn and US$200bn of capital because of a similar level of write-offs and problem exposures.
Blodget’s thesis is that the stock has been tanking because the market thinks BofA is worth much less than management says it is, owing to massively inflated asset values. He said that putting what he considers a more reasonable value on assets and subtracting the difference between that number and current values from book value suggests the bank is insolvent. Punchy stuff.
The bank reacted fiercely to the blog post, calling his claims “exaggerated and unwarranted” and, in an uncharacteristically personal rebuttal, rejected his contention that asset quality is as poor as Blodget was making out.
Leaving aside the spat between BofA and Blodget, and taking into account the latest Buffett cash injection, I suspect the market and the analyst community will continue to promote the idea that the bank will need to increase capital by as much as US$50bn.
Now that Buffett has provided some short-term relief, Moynihan may be tempted to bide his time. But his room for manoeuvre will be determined by the extent to which latest events have pacified the market. If they don’t, he may run out of road pretty quickly.
