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January 15, 2009

How Much Will Bank of America Commons Be Worth?
by Thomas Tan

One of my ten predictions for 2009 is that Bank of America goes to single digit, which is happening today (1/15) and trading below $8 while I am typing this. I didn't expect it happens so fast, especially it traded as high as $18 in December while I wrote my ten predictions for 2009. Here is the excerpt of what I predicted in 2009:

"Bank of America (BOA) falls into single digits (less than $10)......... The trouble for BOA is of its own making with their decisions to purchase Countrywide and Merrill Lynch, both of which have heavy amounts of toxic home mortgages, associated derivative "assets", and OTC credit default swaps. BOA, wanting to be a banking powerhouse like Citigroup, didn't realize that the balance sheet risk from those purchases can wipe out their $70 billion market cap many times over. They want to be the brave guy surfing in a tsunami, instead of retreating far away to the shore, which will overwhelm them and put their going business concern and survivability into a big question mark in 2009."

Yesterday Citi has announced to abandon their previous business model of financial supermarket as the company finally gave up after too long a period of indecision and resistance. Citi now realizes that they will never survive with the highly risky assets in some divisions if bundled together as a whole company.

For over several months, I have suspected that BOA's problem was worse than people realized. Besides their risky and toxic assets inherited from Countrywide and Merrill, I also felt that their large commercial loan portfolio would be in big trouble in 2009. In addition, many people forgot they also purchased MBNA in 2006, how does their credit card loan portfolio look now? For the last 2 years, every acquisition has only added more troubles for BOA one after another, not even considering overpaying Merrill by 3 times.

The biggest surprise I have and never really understand is that in order to pursue their financial powerhouse dream as to compete with Citi, BOA brushed aside the balance sheet risk and didn't take it seriously at all, quite ignorant and irresponsible to run a business in a credit crunch time. Of course, who would really care and safeguard its common shareholders? In a credit crisis, assets are always in a downward spiral, worth less and less through time, while liabilities remain unchanged, wiping out shareholder equity faster than anyone can ever imagine. With all the time bombers in BOA's portfolio exploding at the same time like fireworks this year, I just don't know how BOA can survive?

Of course, they will survive, just like Citi, since BOA is in the government category of too big to fail. Probably in a few months, under government pressure, BOA will do the same thing as Citi, spinning off divisions with toxic assets such as MBNA, Countrywide and Merrill, the infamous "non-core" assets as called by Citi, at one tenth of their original purchase prices. This way, with government's bailout capital, BOA will be back to its original business model of 3 years ago, from financial supermarket back to only retail banking. The problem is that government bailout funding always has a higher hierarchy in bank's capital structure, in debts or at least in preferreds by getting paid at 10% interest to further erode common equities through all future years. What will be left for the Bank of America common shareholders? The answer is probably nothing.

Thomas Tan, CFA, MBA
www.investorwalk.com

Disclaimer: The contents of this article represent the opinion and analysis of Thomas Tan, who cannot accept responsibility for any trading losses you may incur as a result of your reliance on this opinion and analysis and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities. Do your own due diligence regarding personal investment decisions.

Copyright © 2006-2009 Thomas Z. Tan

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