Bank capital structure in the year of FVAOL November 6, 2011 at 12:52 pm
I am sure you could make a case for pronouncing that ‘fvail’…
Dealbreaker points out a nice trick here. Note that:
- Basel III is demanding banks increase the amount of equity they have (as opposed to total capital);
- Some banks, like BofA, have seen large increases in their credit spread;
- If you buy back your own debt at the market price, you can monetise that fair value gain.
So what has BofA done? Buy back subordinated debt and preferreds, and issue both equity and senior debt. It’s cute:
Note first of all that you profit by “volatility in credit spread movements” by buying back the things with the longest duration: perpetual preferred and trust preferreds, which are trading at double-digit percentage discounts to where they were issued. You replace them with a thing that in some loose theoretical way looks similar from a duration and capital structure perspective: a mix of about half common stock (400mm shares = about $3bn on a good day) and half senior notes. It’s a regulatory capital improvement. And you’ll be paying out less cash going forward, since the senior debt should be cheaper than the preferred and, um, about those common dividends. Sure your common shareholders will be diluted, but not so much on an EPS basis, and they’ll be so thrilled with the juiced earnings this quarter that they won’t be too worried about the dilution.
Update. I fixed a typo; thanks to Dennis for pointing that out.