Bank of America Slides as Stockholders Ponder Dilution From Stock-Swap Plan

Friday, 04 Nov 2011 01:33 PM

 

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Bank of America Corp., whose stock lost about half its value this year, led lenders lower in New York trading as the company’s plan to bolster its balance sheet renewed concern that shareholders may see their stakes diluted.

The bank said late yesterday it may exchange preferred securities for a total of $6 billion of common shares and debt, a plan that could cut interest and dividend costs and improve capital levels, according to the Charlotte, North Carolina-based lender. The firm may issue 400 million shares and $3 billion of senior notes, according to a regulatory filing, taking advantage of lower prices for the bank’s existing securities.

While the deals may help Chief Executive Officer Brian T. Moynihan shore up the balance sheet, analysts said it may cost him some credibility. The drop in the bank’s market value this year was caused in part by concern that expenses from faulty mortgages may force the company to issue new stock, a path Moynihan has repeatedly said wasn’t necessary.

“It looks like this will be dilutive to shareholders, but that’s the minor issue,” Richard Bove, an analyst with Rochdale Securities LLC in Lutz, Florida, said in a telephone interview. “The major issue is they said they wouldn’t issue stock, and this may be one too many statements to investors that didn’t turn out true.”

Exchanging Shares

Bank of America fell 4.1 percent to $6.63 as of 10:31 a.m. in New York trading, the biggest drop in the 24-company KBW Bank Index as well as the Dow Jones Industrial Average. The lender’s $2 billion of senior unsecured notes due in May 2021 rose 0.5 cent to 92.8 cents on the dollar at 8:59 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Holders of Bank of America preferred shares and trust securities may receive common stock, debt, or a combination of both, depending on the transaction, said Jerry Dubrowski, a company spokesman. The lender said the deals may help earnings per share for the quarter in which they are completed. Longer term, the impact won’t be significant, the bank said.

Moynihan, 52, is selling assets and cutting staff as part of his plan to reduce costs and comply with stricter international capital standards. He said in August that the bank, which has more than 10 billion shares outstanding, would try to avoid solutions that devalue the stakes of current shareholders, as it had done after its U.S. bailouts in 2009.

“We simply could not continue on a course of diluting our shareholders to build capital,” Moynihan said.

Moynihan’s Stance

Issuing new stock under the exchange plan doesn’t constitute a broken promise, said Matthew Burnell, a Wells Fargo & Co. analyst, in a report to investors with a “market perform” rating. The transactions are “an opportunistic response to the current dislocated market environment, allowing the company to simplify its capital structure, support the company’s debt, book near-term gains that will boost EPS and equity,” and also move closer to its capital targets.

The bank is being consistent with Moynihan’s previous statements because it’s an exchange of stock that doesn’t increase the total capital, Dubrowski said.

“It’s changing the composition of our capital from one that is restrictive to one that is much more flexible and lower cost,” Dubrowski said. “In doing so, we strengthen our balance sheet and provide long-term value to our shareholders, including common shareholders.”

Capital Conundrum

While the bank said in the filing it wouldn’t “issue more than 400 million shares of common stock or $3 billion in new senior notes,” causing some confusion among analysts as to the total amount of securities to be created, the company intended for the figures to be added, Dubrowski said.

Bank of America agreed in August to issue warrants for 700 million shares to billionaire Warren Buffett’s Berkshire Hathaway Inc. as part of a deal to inject $5 billion into the lender, raising the possibility of further dilution.

The exchange plan announced yesterday would dilute current shareholders by at least 2 percent according to Richard Staite, an analyst at Atlantic Equities LLP, who added that the deal “would do little to fill what we estimate will be a $45 billion capital shortfall at end 2012. It also further reduces management credibility,” he wrote in a report to investors.

The bank “has no easy options to fill the shortfall,” wrote Staite, who has a neutral rating on the stock. “Selling assets in the current market might generate a loss and would impact long-term revenues. Alternatively raising equity at the current price is dilutive.”

Stock Assumptions

Most analysts had assumed that Bank of America would eventually redeem its preferred securities without issuing common stock, Ed Najarian, head of bank research at International Strategy & Investment Group Inc., said in a note.

Bank of America had reported a $6.2 billion profit for the third quarter, fueled by one-time gains tied to changes in the value of the company’s debt. The lender paid $343 million in dividends to preferred holders in the third quarter, with some of the securities paying interest rates above 8 percent.

“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,” the bank said in the filing.

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