A Cool $200 Billion for Bank of America?

Includes: BAC, C
by: Ockham Research

“This is what we’re talking about, a report out of Oppenheimer this morning talking about a slew of the banks, particular Bank of America saying they need to raise $36.6 billion dollars in capital. That’s what they will need in equity to bring its capital ratios in line with their competitors.” Fox Business Network 4/8/2009

Bank of America (NYSE:BAC) has been talked about quite a bit today and was the most actively traded issue of the day, as the Oppenheimer research note modeled in a large secondary offering into its earnings projections for Bank of America. It’s certainly not common practice for an analyst to speculate like this in their estimates, and BofA is denying the need for a capital raise at this time.

“It is perhaps unusual to model highly dilutive equity raises into earnings forecasts, but we believe that in the current environment, until credit quality stabilizes and capital requirements are more precisely known, it is the prudent thing to do,” analyst Chris Kotowaski wrote.

He expects to see continued deterioration in the loan loss portfolios because of continuing weakness in the credit markets. According to Kotowaski, the company would need to raise more than $36 billion in order to bring their tangible equity capital as a percentage of risk weighted assets in line with the average of more than 25 major banks. BofA has already taken two rounds of government injections totaling $163 billion worth of preferred stock purchases and guarantees for assets. Add in the prospect of another $36.6 billion raise and that would make a nearly $200 billion raised to shore up the failing giant.Ockham historical valuation BAC

This is exactly what Bank of America did not want to deal with right now, as the markets had seemed to turn favorably for the major banks in the last month. There is still quite a bit of risk in Bank of America and Citi (NYSE:C) among others, as many analysts not just Kotowski, are predicting a very difficult year for commercial real estate and consumer credit such as credit cards. Bank of America could have been down worse on this sort of report, but the market continued to fight its way slightly higher. At the close of trading BAC was only down about 4%, and shares have more than doubled from a month ago.

At Ockham, we believed that these huge commercial banks were Undervalued because it is clear that the government will stand by them and not allow them to fail. However, these banks, including Bank of America, are no longer Undervalued after their hot streak in the last month. We have recently downgraded both BAC and C to Fairly Valued. There is still considerable risk in these companies, even though nationalization is not likely, there could be more pain yet to come in the consumer credit and commercial real estate markets. These commercial banks have a lot of exposure to both of these areas. We are not saying whether BofA will need to raise capital again or not, but we do not see a rapid recovery for them either.

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