Many of the pundits on financial entertainment channels keep claiming that the bank vigilantes want to put banks out of business, or force them to raise capital by excessively, or even naked shorting the bank stocks. One big problem with that though, it won’t work. Not even close.
Without even going into how U.S. banks are currently excessively capitalized (thus delaying the effects of QE2), the general misunderstanding concerns tier one common equity. This is the ratio of common shareholder equity that a bank must hold per new banking requirements to ensure that a major institution will not contribute to or cause a financial crisis. In Europe, the hullabaloo involves the marking down of sovereign debt to appropriate levels, and what condition Euro bank balance sheets would be in after the markdown. So, in essence the bond shorters in Europe are trying to damage bank balance sheets. This is effectively a run on the bank, as they would need to raise capital to maintain regulatory tier one ratios.
In the U.S., this has little relevance. The major U.S. banks have minimal exposure to Euro sovereign debt, and during the conference calls they all disclosed their total exposure to Euro debt including corporate lending. Realistically, if BAC owns Ferrari bonds, do you think they will have to write that down? JP Morgan was very clear about this, they said they will be taking up market share from those banks that run scared of lending to worthy companies in the Euro region.
The bottom line is that by shorting BAC stock, they won’t be forcing a write down of the common equity. BAC is sitting on a ton of cash, unlike in 2008 when all the major banks were looking for deposits to shore up their capital base. In fact, some banks are charging a fee to hold excess cash. In 2008, the shorters were trying to strangle the bank’s ability to access capital from the equity markets. BAC doesn’t need to sell stock.
Once BAC gets the mortgage deal with the Attorneys General behind them, and the AGs are pushing to get this done in the next few weeks, the majority of BAC’s problems will be behind them. They’ve settled with the GSE’s already, and any dispute you hear about, from NY type attorneys trying to make a political name for themselves, will be settled in court. Meanwhile, BAC can easily handle another $25B hit to the balance sheet, when they crank in $35B per year in revenues and 10B+ in income.
Dick Bove even suggests that if BAC stock were worth one penny, it wouldn’t matter. Once you understand how tier one common equity works, then you will understand that he is right. The stock is dirt cheap and universally hated. I hope it goes lower so I can grab some cheap LEAPS. Here is Bove’s interview with Bloomberg. Take particular note of Ms. Brennan’s failure to understand the relationship between equity price and common equity. This is a major public misunderstanding: