Friday, November 4, 2011

Here Comes the Dilution

BofA's image needs buffing.

One of the risks for owners of Bank of America's common stock (reminder: MainePERS owns 2.6 million shares) is the prospect that the firm will issue new shares, thereby inflating the share count and diluting shareholders (discussed here). Senior management has stated repeatedly that that will never, in a million years, happen. The bank's capital cushion, they have said, is as well padded as their own compensation. Or almost, anyway.

Yesterday's release of the company's most recent 10-Q filing with the SEC reveals that such assurances were so much lip service. Scroll down to page 10 and see this:

The uncertainty in the market evidenced by, among other things, volatility in credit spread movements, makes it economically advantageous at this time to consider retirement of issued junior subordinated debt and preferred stock. As a result of these matters, we intend to explore the issuance of common stock and senior notes in exchange for shares of preferred stock and...certain trust preferred capital debt securities...We will not issue more than 400 million shares of common stock or $3 billion in new senior notes in connection with these exchanges.

That's $2.8 billion of new common equity at $7 a share (the current market price rounded up to the nearest dollar). The move actually makes sense from a business standpoint, as it will add to Tier 1 capital (more on that below) and reduce expenses on interest and dividends. But what makes business sense does not always make money for the common shareholder, the low stakeholder on the totem pole.

Bank of America's debt, downgraded six weeks ago, is trading at a discount, and because of this the firm booked a paper profit for the quarter of $1.7 billion (remember DVA?). The debt and capital exchanges now proposed would lock in some of that gain: "The senior notes and common stock would be recorded at fair value at issuance, which is expected to be less than the par and carrying value of the preferred stock and/or the junior subordinated debt." Management assures existing shareholders that the exchanges would be "accretive to earnings per common share." But how? The gains have already been booked, and the share count (the denominator in earnings-per-share) will be greater. Then again, banksters are quite used to having their cake and eating it too. In any case, it remains to be seen how much of this deal gets done. The exchanges must be negotiated with willing creditors. As we have learned this past week, there is no such thing as a voluntary haircut, the Euro-elite notwithstanding.

Back to Tier 1 capital. Bank of America needs more of this in case their debt gets downgraded again. Look at what happened to MF Global earlier this week. A credit-rating downgrade precipitated a liquidity crunch that put the dealer-broker out of business. Could the same thing happen to BofA? Is the Pope Catholic?

So how is business these days? Not so hot, actually. Earlier this week BofA had to cancel plans to institute a $5-a-month fee for debit-card users. The announcement came too late to retain the customers that just moved their accounts elsewhere, but at least there are fewer outraged customers left. A poll released today shows that the rush to the exits may continue. BofA's remaining customers "are the least satisfied among clients of the biggest U.S. lenders and the most likely to defect to competitors." Nine percent are "not at all likely" to stay. Which begs the question, why would that category of users ever exceed zero percent? I mean, what are they waiting for?

Maybe tomorrow is the day that the 9-percenters become the zero-percenters. November 5 is Bank Transfer Day. Have a nice one.

[update, B.T. Day + 1--]

Credit unions have picked up some new customers. Story here.

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