Bank of America to repay TARP money
Bank of America (BAC) said this afternoon that it plans to repay all of the $45 billion received from the government in last fall’s financial crisis some time before the end of the year.
The repayment would be made using resources the banking giant already has and envisions the sale of $18.8 billion in new securities and stock. Many analysts believe the move will help the bank recruit a new chief executive to replace Ken Lewis, who plans to retire at the end of the year.
It will remove the compensation constraints imposed by the government on financial institutions that needed government aid to survive the 2008 panic. It will certainly help the candidacy of Greg Curl, the company’s chief risk officer, who developed the plan. He is widely believed to be the strongest internal candidate for Lewis’ job and may be the interim CEO after Lewis leaves.
The $45 billion was received under the government’s Troubled Asset Recovery Program, or TARP. About $25 billion was forwarded to Bank of America in October. The remaining $20 billion was extended in January as part of a package designed to help the company complete its controversial acquisition of brokerage giant Merrill Lynch. The package also included a guarantee of $118 billion in assets as well as warrants to buy additional shares. The government will have to sell those warrants.
The TARP repayment means that Bank of America’s fourth-quarter net income will be reduced by $4.1 billion — the difference between the book value of the preferred shares and the amount it will pay to get them back. At the same time, the banking giant will save $3.6 billion a year in dividend payments to the government.
Investors were initially skeptical of the news, first reported on CNBC, sending Bank of America shares down as much as 4% after hours. But the shares later rose to $15.99, up 2.2% from the close, which may help stocks open higher on Thursday. Bank of America had dropped 1.5% to $15.65 in regular trading. Repaying the so-called TARP money means buying back three series of preferred shares issued to the Treasury Department.
The bank plans to use $26.2 billion in excess liquidity to fund part of the repurchase. About $4 billion will come from asset sales. An additional $1.7 billion will come from issuing restricted stock under incentive compensation plans. But the big part of the plan involves the issuance of $18.8 billion in new “common equivalent securities.” The company envisions asking shareholder to approve a proposal to let it convert the securities to common shares within 105 days of their issuance.
Many financial institutions that took TARP money last year scrambled as quickly as possible to get it off their books. The managements have objected to government restrictions on compensation and other activities. They’ve complained that talent and business are being drained away by competitors.
On the other hand, as Bank of America’s Lewis implied in the company’s news release, without the assistance, many institutions might have simply failed in the financial panic. “We appreciate the critical role that the U.S. government played last fall in helping to stabilize financial markets,” his statement said.
Bank of America’s vulnerabilities came from heavy exposure to the crashing real estate market. Merrill Lynch had problems that were so bad that the bank considered trying to walk away from the merger. Bank of America shares had plunged to a closing low of $3.14 in March before the stock market recovery set in. The shares have risen 398% since then.
The deal would maintain Bank of America’s capital requirements within acceptable — and higher — bounds. Capital is what companies use to cushion blows from losses. Regulators allowed financial institutions were allowed to drop their capital earlier this decade, which made them vulnerable when the credit crunch erupted in 2008. With the extra $20 billion, Bank of America’s Tier 1 common equity ratio — a key measure of capital — could rise to 8.5%, up from 7.25% in the third quarter.
At 8.5%, B of A would have more than twice the minimum Tier 1 common equity required by the government stress tests in May.
By hoisting capital levels, the government reduces the risk it will have to step back in and support large banks, which would only spook markets again.
