This blog is starting a Bank of America death watch.
It is clear that the Charlotte bank has too much in the way of legal liability that it will not be able to shed and yet-to-be-taken writedowns on balance sheet items (for instance, roughly $125 billion of home equity loans and junior liens on residential real estate as of end of last year) for it not to be at risk of a death spiral. Its stock was down 7.44% yesterday, which puts its market cap at $89.5 billion, which is a mere 41.6% of common equity (total equity less book value of preferred) of $215 billion. That means if the bank is under pressure to raise its capital levels, it will be so dilutive as to be problematic, particularly if the stock market weakens further and banks continue to take it on the chin. And the entire mortgage industrial complex is coming under stress. Number three mortgage insured PMI posted yet another loss and fell short of regulatory standards. Although mortgage insurer woes are mainly a Fannie-Freddie issue, problems in tightly-coupled systems can ricochet in unexpected ways.
The death spiral dynamic kicked in during the crisis as a result of funding stress: as interbank markets dried up and short term funding costs rose, CDS spreads also rose and banks faced risk in terms of both cost and availability of funding. Rating agencies downgrades exacerbated the spiral. Some of these conditions would appear not to be operative now, with banks having tons of reserves parked at the Fed. But BofA in particular has been suffering a slow bleed of depositorss (correction of earlier “deposits”, see comments for discussion as to why the reported increase in deposits on BofA’s balance sheet is more complicated than a superficial reading might suggest) as angry consumers vote with their feet, making it more dependent on market funding than before.
The other way for BofA to shore up its capital level would be for it to sell assets. But it already dispose of the Merrill Lynch stake in Blackrock. Merrill would seem to be the most logical sale candidate, but who would buy it when the logical buyers, other TBTF banks, are now under stress thanks to financial market upheaval? It would seem nuts to allow any of the US TBTF banks to double up on market risk. Citi has been under regulatory pressure to skinny down. JPM is less sound that its PR would have you believe (there is a ton of risk sitting in its derivatives clearing business) but Dimon loves to be the government’s subsidized buyer if things got that far. Morgan Stanley? A sale of a stake to a sovereign wealth fund (the notion that this is a “buy low” in an entity not exposed to mortgage liability?)
Bank of American and Citigroup both had near death experiences in early 2009. Citigroup was forced by the FDIC to trim its operations considerably. Bank of America was not required to make any serious overhaul. The mortgage mess has exposed the weakness of the bank’s foundations. Perhaps it will manage to muddle through again ex extraordinary official measures, but I would not bet on it.
Update 12:00 PM: The stock is taking another dive today, down nearly 7% when the S&P (more heavily weighted towards financials) is down a mere 1.7%. The reaction appears to be a combo plate of digesting yesterday’s release of the 10-Q, the Schneiderman law suit, and the news du jour hasn’t helped either. A prominent story on Bloomberg focuses on this revelation in the 10-Q:
Bank of America Corp. (BAC), the lender that announced a $3 billion settlement with Fannie Mae and Freddie Mac this year, told investors that elevated claims from the firms may cost more than previously forecast.
New demands for refunds on soured loans from the two government-sponsored enterprises are coming “in numbers that were not expected based on historical experience,” the Charlotte, North Carolina-based bank said yesterday in its quarterly filing. Fannie Mae and Freddie Mac are being “more rigid” in resolving demands, said the bank, the worst performer today in the Dow Jones Industrial Average.