$30 billion is a lot of stock. That is the amount of AIG (AIG) stock that the government still has to sell, before it can finish off the AIG bailout. It is a massive amount of supply that needs to be absorbed by financial sector investors. The supply of bank stock that had to be issued during the global financial crisis was massive. On top of that, the current European financial crisis is sure to create even more bank stock. The recapitalization of global banks, coupled with persistent equity mutual fund outflows, makes trying to move $30 billion worth of financial equity a daunting task. Could this supply be holding down valuations of the financial sector as a whole? If so, then when it clears, financial stock prices should slowly drift upward.
Financial Stocks Below Tangible Book Value
There are a large number of large cap banks and insurance companies that trade significantly below tangible book value. Some of the big banks and insurers that trade below tangible book value (TBV) are:
- Bank of America (BAC) - 60% of TBV
- Citigroup (C) - 55% of TBV
- Goldman Sachs (GS) - 80% of TBV
- Morgan Stanley (MS) - 55% of TBV
- American Intl Group - 60% of TBV
- Met Life (MET) - 65% of TBV
- Prudential (PRU) - 70% of TBV
These stocks represent the bulk of the large cap U.S. financials trading significantly below tangible book value. If I left any major names off the list, please let me know. All the above-mentioned stocks have a combined market capitalization of under $350 billion. The $30bn of AIG stock for sale is almost 10% of the total. It is an enormous supply of stock. As large as AIG's overhang is, I have highlighted in another article how the government will likely be able to exit their position by the end of the year, aided by as much as $15bn worth of stock buybacks.
The Elimination of the AIG Overhang
The timing of this overhang being cleared is based on two major events: the liquidation of Maiden Lane III, and the selling of AIG's near 20% stake in the Chinese insurer AIA. The Maiden Lane III liquidation will most likely be completely liquidated by the end of August, while the AIA shares are locked up till September. After these two divestitures, AIG will have over $15bn to buy back stock. $15 billion represents approximately 1/2 the overhang. As the previous offerings have been roughly 50% buyback/50% secondary offering, the government stake should be cleared by the end of the year.
As the AIG overhang is cleared, the above-mentioned stocks (below TBV) will go from a $30 billion supply expansion to a $27 billion supply contraction (not including AIG) as the buybacks from the above-mentioned stocks kick in. At the beginning of next year, big banks will present their capital plans to regulators with requests to conduct buybacks. I see the following buybacks highly probable (there may even be upside to my estimates).
- Bank of America $5bn (now with the highest Basel III Tier 1 capital of all the big banks is ready to buy back stock in line with peers)
- Citigroup $5bn (CEO Pandit requested 8bn for 2011 but had to delay)
- Goldman Sachs $10bn (program already in place)
- Morgan Stanley $2bn (speculative in line with peers)
- AIG $15bn (highlighted in previous article)
- Met Life $3bn (indicated would like to buyback stock)
- Prudential $2bn (buyback program in place)
Buybacks as a Catalyst
Once the buybacks kick in, it is my view that the stocks will slowly move to over tangible book value. The supply contraction from the buybacks is large, and it should have a significant effect on stock prices. Barring any black swan events, by the end of 2013 (if buyback programs are approved), it will be hard to find a single large cap financial stock that trades below tangible book value. This means huge upside for the above-mentioned names.