Sooner is better for Bank of America capital raise - Interesting

Bank of America Corp.’s decision to cut its dividend by 50 percent and raise up to $10 billion in capital was “prudent,” and the company may be better off in raising the new capital now rather than later, according to Wall Street analysts.

Late Monday the bank announced it would cut its dividend to 32 cents per share, down from 64 cents per share. The move will save the company nearly $6 billion annually in capital. In addition, BofA began a $10 billion sale of common stock. The bank said it took the steps in response to what it called “recessionary conditions” that have resulted in increased loans losses and put its earnings under pressure. The bank expects those conditions to continue into next year, Chief Executive Kenneth Lewis said during the company’s earnings call Monday.

BofA is also preparing to add Merrill Lynch & Co. Inc.’s nearly $1 trillion in assets to its balance sheet, which also puts more pressure on the company to add to its capital base.

“We think the prudent decision is to strengthen our capital position now rather than take the risk of being exposed to any number of uncertainties in the United States and global markets,” Lewis said.

Regulators require banks to hold a certain amount of capital to guard against loan losses. By cutting the dividend and raising capital, BofA expects its tier-one capital ratio ­— a key regulatory measure of a bank’s capital — to be around 8 percent, including its $50 billion pending acquisition of Merrill Lynch (NYSE:MER). To be considered well capitalized, a bank must have a tier-one capital ratio of at least 6 percent. At the end of the third quarter, the bank’s tier-one ratio was 7.5 percent.

Charlotte-based BofA (NYSE:BAC) reported third-quarter net income of $1.18 billion, down from $3.7 billion a year earlier. The company’s net charge-offs, or loans the bank does not expect to be repaid, increased to $4.36 billion from $1.57 billion a year ago. Nonperforming assets, or loans close to default, grew to $13.36 billion from $3.37 billion a year ago. The bank said problems in its home-equity and home-builder loan portfolios have spread to businesses such as mortgage and credit cards.

The bank also continues to have problems in its small-business loan portfolio. When asked about the small-business credit issues, Lewis said he was glad the portfolio was relatively small, “but it’s a damn disaster.”

Citigroup Inc. analyst Keith Horowitz says he believes BofA “made the right and prudent decision” to cut its dividend and raise new capital.

In a research note, Oppenheimer & Co. analyst Meredith Whitney says she expects that a “sooner is better” mentality will prevail with future capital raises and “distinguish survivors and the more challenged among banks.” Citi (NYSE:C) and Wells Fargo & Co. (NYSE:WFC) have also announced plans to raise capital tied to their proposed acquisition of Charlotte-based Wachovia Corp. (NYSE:WB). Citigroup said it would raise $10 billion in capital through a sale of common stock and cut its dividend to 16 cents per share. Wells said last Friday it would seek to raise $20 billion in capital, primarily in common stock.

Credit Suisse analyst Todd Hagerman says BofA could continue to face capital issues if its loan quality deteriorates further. Despite the dividend cut and stock offering, Hagerman wrote in a research note, BofA has “little room for error.” He estimates that in a recession scenario the bank could need between $20 billion and $30 billion in additional capital.