BAC, 3-month chart
With yesterday's downward spike in the price of Bank of America's common stock, the "Buffett effect" of one month ago has been repealed, leaving shares near the low for the year.
Why would Warren worry? Super-gazillionaire Warren Buffett, remember, sold all of his Bank of America common in 2010 and replaced it with preferred stock purchased last month. So he would appear insulated from yesterday's slide. But check out the reason for the slide: a downgrade by Moody's Investment Service of its ratings of Bank of America bonds. While preferred shares are senior to common, they are subordinate to bonds. So if bonds are at risk, so too are dividends owed to the preferred shareholders (in Buffett's case, a fat $300 million annually).
Moody's lowered its rating of BofA's long-term senior debt from A2 to Baa1 and, what's more, warned that a further downgrade may be in the cards. From Moody's website:
"Moody's decision to assign a negative rating outlook reflects the possibility it may further reduce its systemic support assumptions in the future as a consequence of the process set in motion by the enactment of the Dodd-Frank Act. Under the rules recently finalized by the FDIC, the orderly liquidation authority included in Dodd-Frank demonstrates a clear intent to impose losses on bondholders in the event that a systemically important bank such as BAC was nearing failure. If fully implemented, the provisions of Dodd-Frank could further lower systemic risk by reducing interconnectedness among large institutions and could further strengthen regulators' abilities to resolve such firms....
if the economic environment were to deteriorate and the bank were to receive adverse legal rulings on the claims pending against it related to its mortgage business, it could have a significant impact on BAC's capital position. Moody's also believes the variability around potential negative outcomes is substantial, and their resolution is not entirely within the direct control of management. The resulting uncertainty is a constraining factor on BAC's baseline credit assessment, especially in light of the bank's still relatively modest capital position compared to its major peers."
BofA's cash flows will be further constrained by the Federal Open Market Committee's decision, announced yesterday, to begin "Operation Twist," whereby the yield curve for U.S. Treasury bonds will be effectively flattened. Banks print money on the difference between short-term rates and longer-term rates, borrowing short and lending long. The steeper the curve (the bigger the difference in rates), the more money they make. That arbitrage is now being squeezed by the Fed in a desperate attempt to goose the economy.
The cost for default insurance for BAC debt remains alarmingly high:
BAC, 5-year CDS spread
