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 For my trouble, some readers suggested I was basing my arguments on outdated capital ratios; still, I didn't expect a banking giant to vindicate me this soon: Yesterday, Bank of America (NYSE:BAC) announced it will raise $18.8 billion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:


Core Tier 1 Capital Ratio*
(Q3 2009)

Price/Tangible Book Value

Goldman Sachs (NYSE:GS)



Citigroup (NYSE:C)



JPMorgan Chase (NYSE:JPM)



Morgan Stanley (NYSE:MS)



Bank of America (NYSE:BAC)



US Bancorp (NYSE:USB)



Wells Fargo (NYSE:WFC)



*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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