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Is Bank of America the Next to Crumble?

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What do you mean the next to crumble? Doesn't Bank of America's (NYSE: BAC  ) 90% plunge in the past year qualify as a "crumble"? Of course it does, but investors have very different opinions regarding whether that plunge has been justified.

Some say it's waaaay overdone, and B of A presents the opportunity of a lifetime to purchase a world-class company that will soon resume its dominance. They point to measures like an adequate Tier 1 capital ratio, the backstopping of some of Merrill Lynch's worst assets, synergies of Merrill's wealth advisory unit, and comments by CEO Ken Lewis that another trip to the TARP trough is off the table.

The other side says the second bailout needed to swallow Merrill's losses is a harbinger of things to come. They point to Lewis' years of reckless top-dollar acquisitions, indebtedness to taxpayers to the tune of $45 billion, estimates of billions of dollars more in future credit losses, and a tangible common equity ratio that leaves little, if any, room for error.

Sounds eerily familiar
The last part is the most important. When Citigroup (NYSE: C  ) recently converted $25 billion of government-preferred stock into common shares, CEO Vikram Pandit said, "This securities exchange has one goal -- to increase our tangible common equity."

Tangible common equity (TCE) is typically an obscure and scarcely mentioned statistic. Investors have long relied on Tier 1 capital ratios and earnings potential to judge a bank's investment merit.

What's changed in the past year is that imploding balance sheets have brought on the possibility of wiping out common shareholders completely. With that bleak reality in place, Tier 1 capital -- which measures a bank's strength irrespective of shareholder classes -- takes a backseat to tangible common equity, which is really what's left over for average Joe shareholders.

Before Citigroup converted preferred shares into common stock, its TCE ratio stood at 1.5%. With the conversion, the ratio strengthens to 4.4% (which is still low -- banks have historically kept the ratio at around 6%). In other words, someone (either from Citi or the government) concluded 1.5% was dangerously low -- low enough to justify diluting the pants off of exisiting investors -- and that something around 4.4% was necessary, at least for the time being.

Back to B of A. While not nearly as dire as Citi, its TCE ratio, at 2.6%, remains among the lowest of the major banks. Every bank is low these days -- JPMorgan Chase (NYSE: JPM  ) sits at 3.4%, Wells Fargo (NYSE: WFC  ) is at 3.2%, Goldman Sachs (NYSE: GS  ) , 4.9%; Morgan Stanley (NYSE: MS  ) , 4.4%. But B of A sticks out as the worst. That's likely why so much pessimism has gathered around this stock in recent months.

So what now?
While comparing B of A to Citigroup is hardly apples to apples, the trend is the same: Banks with dangerously low TCE ratios must raise common capital lest even moderate future losses wipe out shareholders.

For B of A to raise its TCE ratio from 2.6% to the 4.4% Citigroup deemed appropriate would require $43 billion of new capital. With a sub-$4 share price and a market cap under $25 billion, the most sensible way to achieve this is converting existing preferred shares into common stock, just like Citigroup did. That wouldn't be impossible, but it would be extremely dilutive and unnerving to existing investors as the seeds of nationalization begin to sprout. (Look what's happened to Citi shares since the conversion took place.)

Bottom line
The good news is that Bank of America has enough capital to keep it alive, at least for the time being. The bad news for investors is that too much of that capital is in the wrong place -- preferred shares owned by the government. To stabilize and shift capital to where it needs it most -- tangible common equity -- would ultimately be a huge blow to existing shareholders.

The problems plaguing banks today require permanently damaging solutions. Holding out for a rebound once the economy springs back to life misses the point that raising common capital at these levels is severely and permanently harmful to existing investors. Add it up, and the single-digit misery shares are wallowing in today hardly seems unjustified.

For related Foolishness:

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this articleJPMorgan Chase is a former Motley Fool Income Investor recommendation. The Motley Fool is investors writing for investors.

Read/Post Comments (26) | Recommend This Article (96)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 04, 2009, at 5:48 PM, titanicdwn wrote:

    Bankers fiddle while Rome burns. Will FDIC also eventually fail? I shall commit utter blasphemy, and say yes it will. But that would mean the US Government... Now you're starting to get the idea. Contrary to popular opinion, nothing is sacred in the world of money, not even the FDIC.

  • Report this Comment On March 04, 2009, at 6:46 PM, EugeneSpud wrote:

    Keep up the negative drivel and Bank of America is sure to go down. Instead of a help to the market you guys are nothing but trouble.

  • Report this Comment On March 04, 2009, at 6:58 PM, YRDOG wrote:

    One has to look back in history to understand banking. Sometime in the Middle Ages, gold started to be deposited into vaults with paper scripts issued. The paper was easier to carry around than gold. The ah ha moment for the vault owner was when he discovered that he could print up a few extra paper scripts and circulate them as money and get away with it. Thus, modern capitalists banking was born. Today, there is a modern term for this fraud, fractional reserve banking. Banks are allowed to print money out of thin air at a 10 to one ratio to how much actual money they have. It does not take a rocket scientist to see the outcome of this Ponzi scheme. In good times, money flows through the system and everything works fine, especially for the banks creating money out of thin air at a 10 to one ratio. The whole system relies on confidence in the Ponzi scheme. When the confidence is shattered by whatever event (call it credit crisis, bad mortgages,

    derivatives, or whatever), the thin air part of the scheme becomes dramatically apparent and there is a recession/ depression. This has gone on for about 300 years since the Bank of England started the fractional reserve banking at a modest 2 to 1 ratio. Right now, with fear gripping the Ponzi scheme, the only one still investing into the scheme is the US government with taxpayer money, calling it a bailout. It is never a good position to be in, the last one into the Ponzi scheme. The bankers seem to sense this, why else did 20 billion in bonuses go out of the scheme last month? So no matter what the government does to fix the financial problems of the country, a system based on fraud will eventually catch up to itself.

    At least the EU has started to hint at the real cause of the problem by telling banks to deleverage. Until this is addressed as law, we will continue to have boom, bubble, bust and dust. We seem to be heading into the dust part of the game. And they even have a name for this, they call it the business cycle.

    . Listen to the talking heads here talk about trust. Ponzi schemes work when people trust in them. They are telling Obama that he has to talk positive about the economy. Help pump up the scheme.

    This article is talking like there is something to fix. Fractional Reserve Banking needs to be scrapped altogether or deleveraged to about 2 to 1. If not, the same Ponzi scheme will find some players eventually and the next bubble will start.

    The current bailout is not about fixing the system, it is more about stopping an insurrection when the American people realize that they have been Ponzi schemed. That is what FDRs New Deal did, stop an insurrection by giving hope (sound familiar) It did not stop the Depression, World War II did that with 50 million victims. I wonder how many financial whiz kids are currently in the halls of power are whispering about war?

  • Report this Comment On March 04, 2009, at 7:33 PM, titanicdwn wrote:

    EugeneSpud thinks he has a nice comeback. What did you do to stop/start the recent economic collapse? What responsility do you accept for the recent disaster? Had investors listened to me they would at least be holding unto what they invested instead of throwing it into the trash can. Are you one of the people who advised them to put it there?

  • Report this Comment On March 04, 2009, at 8:08 PM, olderdoc wrote:

    I think the idea of it being a big Ponzi scheme has a lot of merit. There is a old horseman's saying. What is a horse worth? Whatever someone is willing to pay for it. Unfortunately I don't think there are to many countries that want to help us out with our overpriced real estate and broken economy. The wealth may come back when other countries need our coal and natural gas. It would be a big help if we learned how not to pour all the CO2 into the air supply. Breeder nuclear reactors would be nice if we knew where to store the waste and we don't lose the fuel to the terrorist's. You can always read a good book, practice a musical instrument, spend time with your family, take hikes. Thanks

  • Report this Comment On March 04, 2009, at 8:29 PM, courtneTHEgreat wrote:

    The next major move for BoA will be seen in the next 50 days. So it is best to stay on the side lines until this passes.

    Other issues and cheating rats will be uncovered this month. This will drive the DOW. But the first sign of flowers will begin in May. It will be a slight ralley but the first quarter blues will look to profit.

    Beware of April 2009! DOW to test 5725! But maybe I will be wrong this time! (or will we just test the 6600 level??)


  • Report this Comment On March 04, 2009, at 9:14 PM, Slobberdoggy wrote:

    While I think there was terrible oversights in observing how much realestate and lending the banks did - the Federal Reserve still controls money supply and Federal Fund Rates. They can slow down the economy regardless if it is based on gold or not. If you truly believe the system will break I think you will be missing out on a lot of opportunities that rely upon our current financial system - money and equities in order to benefit from them. The government can print money to get things going again and until money velocity picks up inflation won't be an issue. Then we can attempt to manage inflation and growth going forward. Things will seem much more straight forward then.

  • Report this Comment On March 05, 2009, at 6:19 AM, 7footmoose wrote:

    for the American economy to survive and prosper it MUST have a well capitalized and functioning banking system, we can argue about the chances of the economy and country failing all we want but if it is to come out of this economic mess the banking system MUST function well, I think everyone will agree it is not currently doing so, BofA in particular is essential to the economy if for not other reason than it currently controls for more than ten percent of the bank deposits in this country, if it fails for whatever reason chaos will ensue due to the panic among depositor which will follow, not even Citi has a domestic deposit base of this magnitude, the next closest institution is WFC, for reason beyond the investment considerations we should ALL hope that there is no true bank failure among these institutions

  • Report this Comment On March 05, 2009, at 7:23 AM, nicko168 wrote:

    Nope..Looks like the next casualty will be GE first caused the stock price is tumbling down very fast. I've a feeling that it will hit to a range of $4, based on the volume it's being throw out (751282,515 k) yesterday..It seems like a time bomb similar to BAC & AIG...It's panick everywhere now..

  • Report this Comment On March 05, 2009, at 8:48 AM, Ikabod13 wrote:

    BOA will make it. They just paid 400 million back to the Gov 3 weeks ago. Every line of business is making money. BOA will make 100 bilion next year. They are righting the ship at Countrywide rewriting loans at a record pace. Merrill is selling Bank services and deposits are up.

  • Report this Comment On March 05, 2009, at 10:42 AM, titanicdwn wrote:

    Ikabod13 is sure painting a pretty picture. But whose advice would save your resources, and money, come end of year? Mine or his? I say following his advice will lead to a worse disaster than thus far. I say again, there is nothing in this country I would invest in, except maybe gold.

  • Report this Comment On March 05, 2009, at 10:46 AM, titanicdwn wrote:

    A better investment would be Vietnam, AFTER next year when the dust settles and major companies realize there is a new rising star in Asia.

  • Report this Comment On March 05, 2009, at 12:13 PM, chuckjr wrote:

    Ah, titanicdwn, you like to incite. It's so obvious in a lot of your posts. I don't know if you're an American or not but if you are and you don't see the good in investing in America then you're not acting like an American, regardless. How about a little help here instead of grousing.


  • Report this Comment On March 05, 2009, at 12:16 PM, ReillyDiefenbach wrote:

    Viet Nam? Isn't that one of them there commie countries?

  • Report this Comment On March 05, 2009, at 6:50 PM, wvcrosby wrote:

    Those that are shorting stocks like Bank of America want to value the banks assets at today's market values. BAC uses portfolio accounting. If one thinks it is fair to value all assets at today's market values, than it is only fair to value future income (discounted properly) and add that number to the balance sheet.

    This is gain-on-sale accounting. These folks that are getting rich by destroying American corporations don't want the public to know the truth.

  • Report this Comment On March 05, 2009, at 7:50 PM, eastephenson wrote:

    Thanks for this useful assessment of the banking mess. I also would really benefit from your Foolish assessment of the insurance companies who became overly dependant on toxic securities and their derivatives.

  • Report this Comment On March 05, 2009, at 9:25 PM, titanicdwn wrote:

    It all comes down to whether or not I am right. If you want my help, ok, here it is. The United States of America is NOT ALMIGHTY GOD. I know that will come as a total shock and blasphemy to some of you, but that is your fault for recreating a new image for GOD. Since this country is not ALMIGHTY GOD, it will die like all things in this world dies. That little bit of theology was free and will not cost you a cent. There is however a price should you insist on believing that, but its not me who determines the cost. Now, as to my advice about your money. Do not let patriotism blind you to cold hard realities. Look at the facts right under your nose. Capitalism has always existed in one form or another since Adam and Eve. Why do you get so hyper if it is not American Capitalism??? Use your head a little bit. You can make make money today, but American capitalism is dead meat, just like the country. The American Dollar Bill will burn right along with the rest of the trash. Trade it for something GOD does not plan on destroying in the near future.

  • Report this Comment On March 05, 2009, at 11:08 PM, onegoodone8 wrote:

    Why is it that your comments on the Bank only appear now? Didn't the bank have a low level of TCE after accepting the first and second loan from the government? Why didn't you mention this before. It hardly does any good on 3-4-09.

    I am somewhat disappointed in you all.

  • Report this Comment On March 05, 2009, at 11:41 PM, chuckjr wrote:

    Dear titanicdwn,

    I rest my case. You may move on now.


  • Report this Comment On March 06, 2009, at 12:28 AM, titanicdwn wrote:

    onegoodone8 appearently has not read many of my posts and is only noticing them now. I was warning about the crash long before it happened, just I am warning you about what is about to happened. Once again, I will be 100% bang on while people like chuckjr are spreading advice which will destroy what you do still have left to save.

  • Report this Comment On March 07, 2009, at 2:48 AM, smgokarn wrote:

    It is high time for those who are hoarding black money to come out in open to save their own country. Every country has tremendous amount of black money that is unused, may be in trillions of dollars.The so called recession is the handiwork of those holding them. If at all you love your country, willingly start making the best use of your hoarded funds with investments.

  • Report this Comment On March 07, 2009, at 7:50 AM, JustaBanker wrote:

    Crazy opinions are fine, misstating the facts is not. Once again the bloggers get their facts wrong. TCE for banks has never been kept at the 6% level. A TCE ratio of around 3% to 3.5% is typical. At 2.6% BAC's TCE is a little bit below historical standards, but nothing like what the ill informed (yet still opinonated) authors of the article indicate.

    Plese do everyone a favor, and get your facts straight before blogging again.

  • Report this Comment On March 07, 2009, at 10:56 AM, 1stGradeStudent wrote:

    olderdoc says we shouldn't pour more CO2 into the air. The atmosphere contains 0.038% CO2. Man contributes 3% of that. So, man's contribution to increased CO2 in the atmosphere is 0.001%

    CO2 is non-toxic and a poor GHG and is required to sustain plant life on this planet.

    Water vapor is an effective GHG and makes up 95% of the earth's atmosphere. Al Gore even agrees with that in his congressional testimony.

    Can't do anything about the water vapor and we probably can't do much about the CO2 either without spending a boatload of money. We would need to double the output of every power plant for CO2 capture. All said and done, it won't make a bit of difference anyway.

  • Report this Comment On March 07, 2009, at 11:12 AM, cmfhousel wrote:


    Regarding your comment that banks historically keep TCE at 3-3.5%:

    "By contrast, the top 50 banks by assets have historically held tangible common equity ratios above 6%, according to data from RBC Capital Markets. The current low levels help explain why many large banks' common shares trade at historic lows."

  • Report this Comment On March 07, 2009, at 12:40 PM, MORK000 wrote:

    Good comment YRDOG

  • Report this Comment On March 08, 2009, at 3:25 AM, graytruelaz wrote:

    I cannot believe how many comments have mis-spelled

    words in them---------just amazing. Bank of America will

    survive and flourish because their Investments were made

    with the future in mind. ALL OF US in the U.S.A. are

    looking to the future, because sadly WE ALL let Greed

    overide commen sense.

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