Getting out from under the government's thumb would seem like a safe move for Bank of America Corp., but factors largely beyond its control will determine whether fully repaying Uncle Sam now proves to be a good decision.
Another downturn or a painfully long economic recovery, substantial credit losses in the company's consumer and commercial books or volatility in capital markets could make B of A wish it kept its $45 billion capital cushion and extra cash longer. Other uncertainties include the integrations of Merrill Lynch & Co. and Countrywide Financial Corp. or who might buy into the upcoming stock offering.
"It is a big bet on the economy," said Alois Pirker, a research director at Aite Group LLC. "There are benefits, but will they outweigh the risks? No one knows what the markets hold for the next year."
William Fitzpatrick, an analyst at Optique Capital Management, said he was stunned to see such an ambitious move to bolt the Troubled Asset Relief Program. "There are still a number of risks embedded in the economy that suggest it may be premature," said Fitzpatrick, whose firm owns about 300,000 B of A shares.
"Liquidity serves as a buffer in case credit turns south again," he added, referring to the $26.2 billion in cash involved with the exit strategy. "What if we hit another downturn, and they go back down to a single-digit stock price? Would there be private capital available, or would they be banging on the government's door again?"
Joe Price, B of A's chief financial officer, told investors during a conference call Thursday that the company was seeing signs of credit stabilization and that the rate of loss in its managed credit card portfolio may have "plateaued," according to someone on the call. Price also said reserve building would likely continue over several quarters but at decreasing amounts.
Federal Reserve chairman Ben Bernanke echoed such optimism in congressional testimony Thursday. "We, as their supervisor, along with the [Office of the Comptroller of the Currency] and others, evaluated their situation and felt that it was safe and reasonable and appropriate for them to pay off the Tarp and we signed off on that," he said.
Robert Stickler, a B of A spokesman, expressed confidence in the decision. "We have always believed we have the resources to survive whatever the economy throws at us — fastball, curveball or slider," he said. "We have made no secret of our desire to exit Tarp … to avoid the stigma of being seen as 'bailed out' and to exit exceptional assistance."
B of A's plan to pay back all its Tarp funding by yearend generally also helps it escape federal limits on executive compensation, which could make it easier to hire a talented chief executive to replace the departing Kenneth Lewis.
Still, analysts who generally backed the company's decision outlined the risks. Anthony Polini, at Raymond James & Associates, said he favored the move, though he acknowledged that the plan would reduce total capital by $25 billion. Tier 1 capital would fall to 11% from 12.5%, even though tangible common equity would improve to 5.8% from 4.8%.
Regulators have put more emphasis on raising tangible common equity this year, notably during May's stress tests.
"It is early in the cycle and Bank of America could underperform as the company is relatively thin on tangible capital and consumer losses are deteriorating," wrote Jefferson Harralson, an analyst at KBW Inc.'s Keefe, Bruyette & Woods Inc. Another area to watch is unemployment; Harralson wrote that his model assumes an 11% peak. National unemployment hit 10.2% in October, and forecasts for its peak vary.
The company still has significant heavy lifting in front of it to absorb its high-profile acquisitions.
Keith Horowitz, an analyst at Citigroup Inc., addressed those deals in his note about the Tarp exit. Countrywide still presents integration and litigation risk "given the volatile state of the mortgage market" and lingering issues over lending practices. Merrill Lynch also remains something to watch, since it was a "large-scale transaction," Horowitz said.
Interestingly, B of A does not have enough common stock available to complete the offering without shareholder approval. That led the company to create a plan where shareholders would be heavily penalized if they fail to ratify a 15% increase in authorized common stock. Employees will also forgo a portion of cash bonuses so that Bank of America can issue $1.7 billion in restricted stock to the work force.
It also remains unclear what the impact might be from B of A's decision to let the Treasury Department sell its Tarp-related warrants. It is among a handful of banking companies that have been willing to take that risk instead of buying them back.
Demand for such securities is facing it first major test this week, as the Treasury was slated to close a Dutch auction for 12.7 million warrants in Capital One last night, with minimum bids beginning at $7.50. Auctions for warrants in JPMorgan Chase & Co. and TCF Financial Corp. are expected to follow shortly.
Capital One and TCF have said they expect to bid on their own warrants, and JPMorgan Chase is expected to as well. All three decided to let the government auction off their warrants when negotiations to buy them back from the Treasury fell through.
Stickler would not discuss Bank of America's position on bidding for warrants.