Winter Comes to the Bank Stocks

Although the now defunct Silicon Valley Bank is viewed as the poster child for gross duration mismatch of bank asset/liability management, the real poster child is the giant Bank of America. ( See: Shulmaven: Random Thoughts on the Economy and the Stock Market - No. 3) How so? As of yearend BAC was sitting on a mark to market loss of a whopping $108 billion in its held to maturity portfolio up from $9 billion the year before. If those losses were recognized on its books it would slash the the common equity capital on its books by 44%. For tangible book value per common share the reduction would be a staggering 62%.

Now lets look at the numbers.

Common Equity/share  -                        $30.61

Adjusted for Mark to Market Loss -      $17.11

Tangible Book Value/Share  -                $21.83

Adjusted for Mark to Market Loss -       $ 8.33

With BAC shares closing Friday at $28.60 this means that instead of trading at a modest 1.3X tangible book value the shares are really trading at a very high 3.4X tangible book. My guess is that when the Federal Reserve adopts new stress tests it will include the hitherto omitted interest rate risk as a key criterion. If that criterion were included it is highly likely that at minimum BAC would be prohibited from buying back stock and increasing its dividend. In fact the Fed might require the bank to cuts its dividend and increase its equity capital. Why? On a mark to market basis BAC currently has book equity capital/assets ratio amounting to a meagre 5.4% compared to its accounting book value of 9.0%. 

Simply put the bank is way under-capitalized. My suggestion for Brian Moynihan, the bank's CEO, is launch a $100 billion rights offering  by issuing 5 billion shares at $20/share on the basis of 1 share for each 1.6 shares held. Sure it would massively dilutive, but the bank would then be freed up to sell its long term bonds and get on with the business of banking.

Mark to market losses of held to maturity assets is not the only issue facing the banking system. FDIC premiums are going to soar to pay for the Silicon Valley Bank depositor bailout and there are huge embedded losses on the banking system's  commercial real estate loan portfolios. As a result much like in the early 1980s when the money center banks were saddled with unrecognized losses on their Latin debt portfolios, bank stocks will have a long slog ahead of them. Winter is here.