When the market found out about Merrill’s shocking Q4 losses and Bank of America’s secret backroom deal to cover them, investors knocked Bank of America (BAC) stock down another 14%, to $7. Now the stock is headed even lower. As it should–because it’s worth zero.
As FBR observes this morning (see below), here is all you need to know about Bank of America:
Tangible Assets: $2.4 trillion
Common Equity: $62 billion
That’s 38X leverage. Put differently, if the value of Bank of America’s assets drops by $62 billion, or 2.6%, common shareholders own nothing.
Now let us ask you a question:
Given the rate at which global debt assets are depreciating, given the cascade of defaults from subprime to Alt A to prime to commercial real-estate loans to credit cards to business loans, do you really think Bank of America’s assets are NOT going to drop by 2.6% over the next several quarters?
FBR on BAC:
We reiterate our Underperform rating on Bank of America and reduce our
price target to $5, equal to 0.4x of historical tangible book value.
The bottom line is BAC is undercapitalized in our opinion, and
valuation should remain under pressure until its capital base is
strengthened. In 4Q08, BAC and MER lost a combined $17.1 billion ($15
billion loss excluding goodwill). The company enters 2009 with just
$61.7 billion (pro forma) of tangible common equity, supporting $2.4
trillion of tangible assets. While loss sharing agreements reached
with the government suggest that future losses could moderate from 4Q
levels, given continued growth in credit costs and remaining capital
markets exposures, our best-case scenario is that BAC does not return
to profitability until the second half of 2009. BAC’s pro forma
tangible common equity (TCE) ratio of 2.6% is just too low in our
opinion, particularly for a company with questionable near-term
profitability and credit costs. We reduce our 2009 operating EPS
estimate to -$0.40 (from +$2.00), and initiate a 2010 estimate of
$2.00. We note BAC’s growing preferred balances are an increasing drag
on earnings, which should reduce net income available to common by
$5.6 billion in 2009 and $5.8 billion in 2010 and 2011.
* Recent events: 4Q08 results and government intervention. On
January 16, BAC announced a 4Q08 loss of $1.79 billion, its first
loss in over 15 years. Merrill Lynch, not yet consolidated, lost
an additional $15.3 billion, which prompted BAC to ask the U.S.
government for assistance, consisting of $20 billion more TARP
preferred and a backstop on $118 billion of assets. Losses largely
reflect credit quality deterioration and write-downs on capital
* FBR takeaways. Bank of America’s pro forma capital will include
$77 billion of preferred equity and just $62 billion of tangible
common equity. We are concerned that common equity is no longer
the dominant form of capital at Bank of America. In addition, we
are concerned that preferred dividends will reduce common EPS
approximately $0.90 for the next three years at least, which
impairs the company’s earnings power and puts further pressure on
already strained capital levels.
* FBR value-add. BAC issued $18 billion of stock on January 1 to
acquire Merrill Lynch, but its tangible common equity will
increase by just $12.2 billion, including a benefit from writing
down Merrill Lynch’s debt by $15.5 billion. Pro forma for MER, BAC
has $61.7 billion of TCE, supporting $2.4 trillion of tangible
assets. It would take another $80 billion of equity to raise its
TCE ratio to 6%. Bank of America’s dividend cut prudently
conserves $8 billion annually, but $5.6 billion in annual
preferred dividend payments reduces its ability to retain capital.
The conversion of BAC’s $49 billion of TARP preferreds to common
would go a long way to strengthening its capital structure.
* Valuation. BAC trades at 0.6x of 4Q08 tangible book of $11.44, but
we have little confidence in book due to the lack of clarity on
future credit losses. Shares trade at 3.6x our 2010 EPS estimate,
but we have little confidence in earnings two years out,
particularly as we have not modelled potential dilution, which we
consider a significant risk. Of note, Bank of America’s $46
billion market cap is now less than the original purchase price
for Merrill Lynch.
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