Bank of America Dilutes Shareholders. Who's Next?

Within the last 10 days, I wrote two articles warning investors about the risk of share dilution at top banks. For my trouble, some readers suggested I was basing my arguments on outdated capital ratios; still, I didn't expect a banking giant to vindicate me this soon: Yesterday, Bank of America (NYSE: BAC  ) announced it will raise $18.8 billion through an equity offering -- part of the largest ever capital raising by a U.S. bank -- in order to help repay $45 billion in government bailout funds.

The implied standard vs. the official standard
BofA's capital raising plan will get it out from under the government's yoke in terms of pay restrictions and will raise its Tier 1 common equity ratio from 7.3% to 8.5% -- more than twice the minimum target for the end of 2010 (4%) defined in the government's stress test methodology. That suggests the government's true standard for "too-big-to-fail" banks is higher than the stated minimum ratio. With that in mind, who'll be next to dilute their shareholders? The following table provides some clues:

Stock

Core Tier 1 Capital Ratio*
(Q3 2009)

Price/Tangible Book Value
Multiple

Goldman Sachs (NYSE: GS  )

11.6%

1.93

Citigroup (NYSE: C  )

9.1%

0.89

JPMorgan Chase (NYSE: JPM  )

8.2%

1.66

Morgan Stanley (NYSE: MS  )

8.2%

1.16

Bank of America (NYSE: BAC  )

7.2%

1.37

US Bancorp (NYSE: USB  )

6.8%

3.87

Wells Fargo (NYSE: WFC  )

5.2%

2.45

*Note that the Core Tier 1 Capital ratio is not exactly the same as the Tier 1 Common Capital ratio.
Source: Capital IQ, a division of Standard & Poor's.

Most conservative or undercapitalized?
Suprisingly, the two banks in our table that are widely considered to be the most conservative are now the only two that appear to be significantly below the new capital adequacy benchmark set by B of A: Wells Fargo and US Bancorp. In that regard, I believe they are likely candidates for a dilutive common stock offering (I was off the mark last Wednesday in singling out Citigroup as most likely to require a capital raising) and they also happen to be the most expensive on the basis of price-to-tangible book value -- whether or not their share price is vulnerable to a forced dilution is a legitimate question.

Don't rush to sell, verify
Not that an equity dilution will necessarily provoke a share price drop -- indeed, B of A shares are up today as I write this, while the KBW Bank index is in the red -- however, as I wrote on Tuesday, investors need to be compensated for the risk of dilution by verifying that current prices maintain a margin of safety.

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Alex Dumortier, CFA, has no beneficial interest in any of the companies mentioned in this article. Try any of our Foolish newsletters today, free for 30 days. Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (17)

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 December 03, 2009, at 4:17 PM, ron153 wrote:

    Wells Fargo isn't in a hurry to pay back TARP because it is intelligently managed. While short-term traders are encouraging an equity raise and creating rumors of its inevitability, patient investors will be very glad that Wells refuses to dilute shareholders by acting precipitously. In everything it does, Wells takes the patient approach, which will prove very rewarding over time. The stock is an extremely attractive value.

    You can't ascertain credit quality by a summary table of percentages. That is why the stress tests were so ridiculous.

    Wells Fargo is the largest equity holding in my personal and client portfolios. It is also the only stock Warren Buffett owns personally, other than Berkshire. Wells is also Prem Watsa's largest investment holding. Take advantage of the market's ridiculous behavior here.

    Ron Beasley

    www.rwbi.net

  • Report this Comment On December 03, 2009, at 4:35 PM, wwloke wrote:

    Slight note - you've actually picked up Core Tier 1 Common in the table above, not Core Tier 1 ...

  • Report this Comment On December 03, 2009, at 5:27 PM, rd80 wrote:

    Alex,

    You use "Core Tier 1 Capital Ratio" in the table, the stress tests were based on "Tier 1 Common Ratio" and your two previous articles used "Tier 1 Capital Ratio."

    This is the first time I've seen the term "Core Tier 1 Capital Ratio." How about a brief summary of how it differs from "Tier 1 Common" and "Tier 1 Capital" ratios?

  • Report this Comment On December 03, 2009, at 10:52 PM, cobrabill wrote:

    Not exactly an unbiased opinion there, ron153. And the shameless link at the end renders your comment completely pointless.

  • Report this Comment On December 06, 2009, at 5:40 PM, philipmax wrote:

    US Bancorp already repaid the TARP and redeemed its WTS. They also issued common and preferred securities but the amount was not released.

    In addition, the bank acquired numerous branches from defunct FDIC banks and I expect that the income stream from these branches will be accretive to earnings in the near term.

    So, I am not sure that you can issue a blanket statement that this bank is most likely to issue additional dilutive stock.

    The ratios that you inserted might not be relevant in that WFC , BOA, and C have not paid back the TARP and JPM may still be on the hook for WTS that may dilute stockholder's value in the future. The capital ratios then, do not reflect actual bank cash needs, being that USB already parted with a huge bundle of cash and still meets the standards of capital requirements. IF C or BOA were to pay down TARP they'd be toast.

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