Bank Of America: Ruled By Fear And Headlines, Not Logic

Aug.24.11 | About: Bank of (BAC)

Bank of America (NYSE:BAC) shareholders have experienced huge losses in the past few weeks, and at around $6.15/share, BAC could very well be trading under $6 by next week. The recent sell-off can be attributed to the apparent fear and anger that investors have towards Bank of America. With all the media and analysts predicting doom and gloom for Bank of America, it is very easy to get sucked into the whirlwind of emotion surrounding this stock.

People Are Afraid

Everywhere you turn there is some analyst saying that Bank of America needs to raise $50 billion in capital in order to meet Basel III and future lawsuit obligations, or Bank of America's book value is inflated by up to $200 billion, or Bank of America has untold sovereign risk exposure in Europe. Sometimes analysts even use misleading phrases like "Bank of America only has $65 billion in equity left", as if share price has any impact on Bank of America's ability to continue operating. I could go on and on, but you get the picture. I am going to go through four of these unfounded fears, and disprove them. I will be using publicly available information obtained from Bank of America's most recent 10-Q.

Fear 1: Bank of America Needs to Raise More Capital

This is not true. A few weeks ago I wrote an article outlining how Bank of America does not need any more Tier 1 common capital. In this article I assume a worst case scenario of a complete and immediate write down of all 30 day past due loans (with no recovery rates, cure rates etc.) I am not going to rehash the article, you can read it here. Needless to say, even with the immediate write-down, and all the provisions for lawsuits and loan buybacks Bank of America would fall in line easily with Basel III requirements.

Why are the analysts saying that they will need $50 billion in capital? As reported by Barrons:

The math they came to get BAC to Basel I T1C in line with C they need about $40-$50bn.

It is ridiculous that this analyst is making one-sided statements that Bank of America will need to raise capital because Citigroup (NYSE:C) has will have a 8-9% Tier 1 ratio years before it is required. Big banks will not need to have that high of a ratio for years. The analyst is also disregarding the huge amount of non-core assets on Bank of America's balance sheet, which could easily be sold, and reduce risk weighted capital, while increasing Tier 1 capital.

Fear 2: Bank of America's Book Value is Overstated by $100-200 Billion

According to Bank of America's 10-Q, Tangible Book Value is around $12.65 a share. This is excluding intangible assets such as goodwill. I guess ZeroHedge, and has-been trader/criminal, Henry Bloget, know more than Bank of America's auditors and management. Not likely.

Fear 3: Bank of America Has Huge Sovereign Exposure to the PIIGS

Again, lets go into Bank of America's 10-Q and get the facts, not conjectures and theories based on emotions and opinions. Page 106 shows that total sovereign exposure is a mere $119 million (after applying CDS that Bank of America bought to protect itself from losses).

Fear 4: Bank of America's CDS are at 395 bps Bankruptcy is Days Away.

I don't know if the CDS spike is due to the stock price decline or vice versa, but Bank of America is not going bankrupt anytime soon. According to its 10-Q, Bank of America has cash and cash equivalents equal to $119 billion, $20 billion in liquid short term investments, and trading assets outnumber trading liabilities by around $75 billion. To top it off, Bank of America has enough cash to payoff all of its short-term debt today, and still service it's long-term debt.

Conclusion

I am not saying there is no risk associated with Bank of America. Check my research, and make your own decision. This stock is ruled by headlines and fear, plain and simple. Analysts keep saying that the market believes they need to raise more capital, but the market is not always right. I think that it is quite possible for BAC to drop to $5/share in the short term, but it is a great long-term investment for a brave value investor. Stop listening to the headlines and fearmongers, don't follow the herd, do the research, and make your own decision.

Disclosure: I am long BAC and I am also short September 17 $5 puts.