Bank of America’s quarterly numbers were pretty bad and it showed all that is wrong with the economy. There were the customary write-downs on CDOs and leveraged loans. losses in investment banking and trading. More importantly, all the reserves taken against consumer loans and credit cards. those reserves are typical in a slow economy, people will default on their loans when they are out of a job. It remains to be seen if the reserves taken by BofA are conservative, which I believe they are, then they will report better numbers in the future.
In spite of BofA’s downbeat outlook for the rest of 2008, the bank is standing firm on its hefty dividend. At 7.5 per cent, BofA’s Tier 1 capital ratio is below its target of 8 per cent, but above the 6 per cent level regarded as a minimum for being well-capitalized. BofA's CEO has reaffirmed the bank's commitment to its dividend policy and will only consider if the economy went into a deep rescission.
As an investor I do not like the dividends to be cut, but I'd rather than than equity dilution. BofA has many options to boost its capital ratios:
- Asset sale: BofA can sell Visa stake, Chinese bank stake, investment banking division, which is underway right now.
- Less loan underwriting, which is happening right now.
- Issuance of preferred shares, and
- lastly a dividend cut.
As a shareholder I would rather have the dividend cut than equity raising. I do not want to see my ownership get diluted by raising more shareholders equity. Dividends can be reinstated in the future but ownership and earnings dilution is hard to compensate for.
4 comments:
What are your thoughts about getting into BAC with an arbitrage position by purchasing CFC?
Thanks Sami
it is a cheaper way to buy BAC. your possibilities are as follows:
1. the deal go through you get a nice premium
2. the deal get renegotiated higher, it will only be negotiated higher not lower due to activist involvement, you also win
3. the deal do not happen the outcome here is not clear.
I think my money is on outcomes 1 or 2. Outcome 3 has a very low probability of occurring. so I think that trade has a high expected positive return.
I actually like it.
Thank you for answering my post, Sami. One of the issues I have with this position is that I strongly believe we are going to see further decline in bank earnings due to additional writedowns over the next few years. I don’t believe we are in the 7th or 8th inning as the media is reporting. The loans that are currently going through the financial system are from higher quality (although not good quality) loans. The worst of the worst loans issued in 2006 and early 2007 have not yet made their presence felt.
I am with you on that view. If you read my earlier posts, I acknowledged that returns on banking will under perform in next year due to lack of growth in revenues. I acknowledge that I have made an error when I bought banks earlier this year; I underestimated the effects of the credit cycle.
but I think that BAC have made large increases in their reserves in Q1 relative to other banks like JP Morgan and Citi. So it can fair better than the others.
I still like BAC and USB as retail bank and their management are solid as well.
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