Wednesday, May 6, 2009

All lies and jest

Please note - I am aware this note provides a selective interpretation of a New York Times article - and being selective is likely to be wrong.  

In The Boxer (from Bridge over Troubled Waters) Art Garfunkel sings that a man hears what he wants to hear and disregards the rest.  Like many a good song lyric it holds an underlying truth.

And I risk hearing what I want to hear about Bank of America.  I could be wrong.  I am long the stock for a few dollars so far – and being long probably have selective hearing.  But there are plenty of people intellectually (and financially) committed to the idea that BofA is insolvent – and they are also hearing what they want to hear.  

There is a lot of talk about Bank of America failing the stress test.  The number that they need to raise varies from more than $10 billion to $45 billion with $34 billion being the consensus number of today.  [I round $33.9 to $34 billion - what is a hundred million dollars between friends?]

The New York Times seems to quote original sources … and manages to pin down a senior BofA executive (Alphin) by name.  That is better than most papers have done.  The usual source is “people familiar with the matter”.

Now here is a quote:

Mr. Alphin said since the government figure [$34 billion] is less than the $45 billion provided to Bank of America, the bank will now start looking at ways of repaying the $11 billion difference over time to the government.

So lets get this straight…

A while back Ken Lewis was talking about repaying the entire $45 billion in TARP money.

He backed off.  He said at the annual meeting that the required capital was not in BofA’s hands.

Now they are talking about repaying $11 billion.  That leaves $34 billion – capital which the government says that they need.

This hardly sounds like they need fresh tangible common equity.  Just that the TARP money is a decent buffer and will convert if the tangible common ratio falls below some threshold.  

This interpretation is consistent with the denials the other day by BofA that they were looking to raise $10 billion.

Incidentally this is way better than I originally thought.  The tangible common to tangible assets (not including excess cash balances) is well below 4% now.  Even as a long I think some dilution is warranted.

That said - the quality of leaks on the stress test to date has been awful. 

And maybe Mr Alphin’s comment is also misquoted.  And maybe I am way off base.  In my interpretation.  

Maybe Simon and Garfunkel were right – it is “all lies and jest”.  That is about par for bank accounting and behaviour.

7 comments:

babar ganesh said...

one thing i am unclear about:

why are the prefs treated differently than common stock for tangible common equity purposes?

the TARP prefs are tier 1 capital so why do they not get the same treatment as equity for solvency calculations?

Anonymous said...

Therefore, does this mean that under a worst case scenario whereby losses signficantly exceed earning power (pre-prov pre-tax profits) and begin to deplete TCE that BAC would have to raise or convert 34B of TARP funds. So, the headline suggests BAC would have to raise 34B today...which is not the case?

John Hempton said...

In answer to babar ganesh's question...

THEY CHANGED THE RULES.

I was reading bank accounts for years before the TCE ratio became fashionable.

The GOVERNMENT CHANGED THE RULES. Do not forget it.

And to Anon's question - yes - if the losses exceed the pre-provision earnings power the company would probably need to free up some capital.

There are easy things - selling Franklin, the Chinese bank, shrinking the securities book and selling some assets to the Geithner funds.

There is hard stuff too.

J

William said...

If BAC runs higher they can always convert some of their private preferred at a premium. For example, if BAC can run to $15 they could convert some preferred at a price of $20 and raise $20 billion of equity that way for a cost of dilution of 1 billion shares.

If normalized earnings are $30 billion a year you are still looking at nearly $4 per share earnings a few years out.

Let's also remember that their stakes in Blackrock, CCB, Banco Itau, and Banco Santander are worth around $40 billion.

babar ganesh said...

yes, they changed the rules, but what is their rationale or what can you say their implied rationale is given the rule change?

John Hempton said...

babar - no idea,

seriously I think learning as you go along...

Anonymous said...

Imho you are all using 10yr old methods of analysis (in a bull mkt assets inflation environment)......how is 3-4% TCE going to be enough of a cushion in an asset deflation environement where assets are declining by 10-70% and many more shoes will be dropping. In addition, banks are too riskaverse to take advantage of interest rate margin and investment banking is dead (for now)....by the way converting pfrds to common equity does not add more cushion!
what am i missing?

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