Thursday, May 7, 2009

Bank of America Needs an Additional $34 Billion

The Obama Administration has leaked the results of its Stress test for the nation’s 17 largest banks. The Bank of America wins the award for the neediest, apparently requiring almost $34 billion in new capital infusions.

Let me repeat, the entire Board of Directors of the Bank should step down. Led by CEO Ken Lewis, they breached their fiduciary duties to the shareholders, violated securities laws, exhibited gross derelictions of duty, and otherwise were grossly incompetent. They sold out the shareholders and may well have to sell out the Bank to the government.

The “stress test” is a peculiar test. It is a novel, non-legally required analysis. Apparently, it is a semi-worst case scenario, in which the banks are asked if they possess sufficient capital to withstand a further financial crisis. The technical test is to estimate their losses in an unlikely continual financial meltdown over the next two years, and then subtract current capital and projected profits for the next two years. The balance is the capital “deficit” which must be accounted for by June 7.

The banks currently meet the mandated capital requirements with a cushion.

Yet, even the well managed, and well-capitalized Wells Fargo Bank, is $15 billion short on the stress test.

Something is critically wrong with the government methodology!

But back to the B of A.

The shareholders recently voted to strip Ken Lewis of his position as Chairman of the Board, voting that the Chair and President should be held by different persons. The victory may be pyrrhic.

The response of the Board was to thumb its collective noses at the shareholders. It replaced Lewis as Chair with Walter E. Massey, a distinguished academician and Board member for 11 years.
Dr. Massey is 71 years old, and must step aside from the Board next year because of the Board’s mandatory retirement age of 72.
Lewis retained all his major powers, including the CEO position. In other words, the Board rearranged the desk chairs on the Titanic.

The Directors were gratified that they were reelected with about 2/3 of the shareholder votes. Since board elections usually receive the same 99.9% vote as Communist dictators, the loss of 1/3 of the vote is a stinging rebuke. Had the stress test results been released before the vote, the Directors would have been less gratified with the results.

The Directors won because brokerage firms currently vote for management their custodial shares unless individual shareholders request a contrary vote. The SEC is changing the rules next year.

However, in light of the stress test, B of A is considering changes on the Board.

The problem for the Bank, which accounts for roughly 45% of the cumulative $75 billion the banks must raise, is how to raise $34 billion in new capital. The capital markets cannot fill that need today, and issuance of that much common stock will further dilute the current shareholders.

The Bank can sell assets, which are usually the most valuable with the greatest potential for growth, in a bear market. It is considering selling $8 billion in stock in the China Construction Bank, a leading bank in China.
That will still leave the Bank $26 billion short, but bring needed cash into the Bank.

It can also encourage the current holders of about $33 billion in preferred stock to convert to common. Therein lies the absurdity of the stress test. Such a transaction will neither add to, nor subtract from, the actual solvency of the Bank. It is simply a bookkeeping transaction which does not add to the financial resources of the Bank.

The final recourse will be to go back to everyone’s favorite uncle, Uncle Sam, and either issue new securities to the federal government or convert their preferred into Bank of America common stock.

Ken Lewis, twice national banker of the year, should have bailed out of the Merrill Lynch acquisition when he realized it was a disaster.

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