Friday, January 16, 2009

Bank of America and Citigroup: Giants reduced to Pygmies-no offense intended to Pygmies

The deal actually reported between Bank of America and the government adds a few details to the description given in news reports last night.  The government will inject 20 billion in exchange for preferred stock yielding 8%.  The amount of toxic assets was identified at 118 billion with Bank of America assuming responsibility for the first 10 billion, the government will eat the next 10 billion, and then the government will assume 90% of the losses above 20 billion. (WSJ story has 90% over the first 10, while others differ including FRB release)  BAC will pay the government an insurance type premium of 3.4% of those assets for the backstop (about an additional 4 billion in preferred stock paying 8%), plus 2 billion in stock warrants. The dividend will be reduced, as expected, to 1 cent a quarter.  It would be reasonable to expect that this nominal dividend rate will hold for at least one year, possibly for several years, until BAC  is able to redeem the government's preferred stock.   This is a similar arrangement to the most recent bailout of Citigroup.  So, it is certainly a better deal for Bank of America than the market would give it.  BAC could not convince investors to buy preferred stock with a 8% coupon now.  BAC also reported worse than expected earnings, losing 1.79 billion or .48 cents a share. Provisions for credit losses jumped to 8.54 billion and credit card losses increased to 7.16%. 
The above link provides the best description of the details in its "Term Sheet" PDF link. See also,WSJ.com MarketWatch NYTimes.com
A lot of Merrill's toxic assets were derivatives with a maximum loss potential of 81 billion. Those derivatives reference residential and commercial mortgage pools and corporate debt, plus assorted hedges. 

If you want to start the day in an irritable mood, please read this NYT article about Merrill's compensation paid to the people who destroyed it. NYTimes.com
Before reading that article, I had previously read others that anyone at Merrill who tried to stop the train wreck was pushed out. 

The CPI fell .7% last month.  Yahoo! Finance This will have an adverse impact on the floaters, like OSM, that tie interest payments to CPI.  

This establishes beyond any reasonable doubt, to me at least, that the Merrill acquisition was a catastrophic mistake and the BAC shareholders were not told material information before voting on the acquisition.  I did vote against it.  I am sure many mutual funds would have voted for it notwithstanding this recently disclosed material information.  I think that some lawsuits will soon be filed against BAC on this transaction.  These revelations further show that Stan did in fact run Merrill into the ground.  An honest appraisal of its net worth before the BAC acquisition, assuming no government assistance, would have been zero.   

While BAC may rally today or the next day, I view the stock to be at best dead money for a year or two.  I may consider adding to my position no sooner than the middle of 2010 and only if I could buy 100 shares then at less than the current price. Remember that Citigroup rallied after the announcement of its bailout by the government only to fall back to its low in a few weeks.  I see no hope for existing BAC shareholders for the foreseeable future.  An optimist may see a ray of light at the end of the tunnel sometime in 2010. 

A lot of mutual funds, ETFs and closed end funds whose objective is to hold high dividend paying companies have large positions in BAC.  Since financials had been a source of dividends, many of those funds are heavily exposed to financial stocks, particularly banks, that have been slashing their dividends.   This is a list of some of the ETFs that focus on dividend stocks and each one has to be assessed separately on their exposure to bank stocks.High-Dividend ETFs - Complete ETF List  The SSGA sponsor of ETFs changed its web address, made the overall presentation worse, and the pages now load very slow.  SPDRs - View AllIt is the sponsor for BWX, WIP and TFI, bond ETFs, that I own and it has one of the main dividend ETFs which I do not own.  I do not own these dividend ETFs due to their exposure to financial stocks.  This is the new link to its SDY product SPDR S&P Dividend ETF
 This site from SSGA is very unfriendly to IMAC users.  It is probably best viewed using a Windows operating system with internet explorer, and some pages will not load at all using an IMAC with either the safari of firefox browsers (even if you turn off the pop-up window blocking).     

Citigroup reported its fifth consecutive loss losing 8.29 billion in the 4th quarter, and will split itself into two operations.    NYTimes.com
As I have said, if I go totally off my rocker, and let the wild and crazy guy go off the reservation, I might venture into Citi by buying 50 south of 2.  If the sensible part of me is asleep, then I might even move that target up to 3.  Otherwise, even the wild and crazy guy will let it pass. 

A good description of the House Democrats 825 billion stimulus bill can be found at  WSJ.com



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