naked capitalism

Bank of America’s actions continue to betray its words. CEO Brian Moynihan bravely maintained in an investor conference call last week that the beleaguered bank would be around for the next 230 years and did not need more new capital. He nixed selling equity at its current price levels, because it would be highly dilutive.

Yet we and others have raised the issue that the bank is in a corner in dealing with its not so hot balance sheet. Not only are equity sales an alternative the bank desperately wants to avoid, but the other route back to health, earning its way out, looks constrained. Bank expert Chris Whalen forecasts reduced profits for major banks. And the industry seems to see that coming too. A Financial Times story yesterday reported that top global banks were making serious headcount cuts based on their expectation of earnings pressure.

So what’s a struggling bank to do? If you are in a leaky boat, you throw anything disposable overboard and bail like crazy. But BofA is in the weird position of having potential a long term solvency problem without immediate liquidity pressures. So while selling dispensable operations is a good strategy right now, it needs to sell ones where it can show a profit over book vale or otherwise have a favorable impact on its capital levels.

And the Charlotte seems a wee bit eager to dispose of assets. It is keen to ditch its 10% holding in China Construction Bank, but there are no nibbles, since between rights issues and equity floatation, Chinese banks are selling stock at a frenzied pace to strengthen their capital level to comply with soon-to-be-implemented Basel III requirements. If BofA does not unload this stake and CCB, as expected, also launches a rights offer, BofA will have to particpate, plowing more capital into an operation it wants to unload.

It is faring better in its efforts to offload its foreign credit card operations. Per the Financial Times:

BofA, whose stock has fallen by more than 40 per cent this year, said Monday it had agreed to sell its Canadian cards business for about $8.5bn to TD Bank and pledged to sell its bigger UK and Irish cards portfolios. Its shares rose 7.8 per cent on Monday to $7.76….

The MBNA sale will be a boost to BofA’s capital ratios. Although it is not huge in the context of the $1,400bn risk-weighted assets on its balance sheet, the effect is amplified because the credit card business is counted as risky under regulatory rules and the owner therefore has to put more capital against it than other assets.

The article points out that that the UK portfolio will not be such an easy sale. While there are some logical buyers, like Barclays, it remains an open question as to whether they regard this opportunity as a real priority.

I don’t mean to leave readers with the impression that Bank of America is in imminent peril. The bank is in many ways a victim of the Geithner stress test/extend and pretend charade. BofA and Citi were on the verge of failure in early 2009, and the powers that be chose to go easy on them and rely on cheerleading, regulatory forbearance, super low interest rates to provide easy, low risk profits, and some capital raising. The problem is that everyone drank the Kool Aid and BofA didn’t take aggressive enough action, either on boosting its equity or shrinking its balance sheet, when times were better.

However, the bank faces a growing wave of mortgage litigation. Even though it gets occasional breaks, the news on that front is on the whole negative. Yes, it had a positive development today, in that several securities lawsuits were consolidated and put before a believed-to-be-friendly judge. But on the negative side, another state attorney general, Catherine Masto of Nevada, indicated she had reservations giving a broad release of liability in the so-called 50 state attorney general settlement. Note that this sort of release is what Bank of America needs to help calm investors; anything short of that is pretty useless. We’d indicated that Masto would not join, but taking a stand publicly is far more powerful than remaining silent, and it provides confirmation of our thesis that those talks are in far more trouble than the reassuring PR would lead you to believe.

Bank of America could limp along for years in a less than healthy state; it could take a long time to see how these mortgage lawsuits play out. Recent setbacks suggest that the hope of settling them on the cheap is waning fast. But bank confidence is a fragile thing. If the bank’s stock price continues to languish and CDS spreads remain elevated, it may simply take the wrong turn of events, say the expected Eurocrisis, which will lead to heightened concern about counterparty exposures, and some new bad BofA revelation, to trigger an unwind. I’d rather not be proven right on this one, but the risk is all too real.