BACk to the Trough, err TARP
On Friday, the Treasury Dept issued a press release outlining the terms of Bank of America’s second dip in the TARP pool. BAC also announced a 4th quarter loss of $1.8 billion and a quarterly dividend cut to a penny a share. That loss does not include the results from Merrill Lynch since that acquisition didn’t close until 1 Jan; Merrill’s losses during the quarter were cited as the reason for going back to the government for another chunk of TARP money. Note that the purchase price for Merrill is irrelevant to the new run on TARP since it was an all stock transaction.
The new government funding for BAC comes in two parts, a $20 billion preferred stock capital investment from TARP and a backstop on a pool of loans provided jointly by the FDIC and Treasury.
The loan backstop protects BAC from losses on a $118 billion loan pool. Under the agreement, BAC is responsible for the first $10 billion of losses. The next $10 billion of losses will be split 90/10 between the government and BAC. The Federal Reserve will establish a non-recourse loan facility for 90% of any additional losses over $18 billion. If I read the term sheet correctly, responsibility for losses goes like this:
0 - $10 billion – all BAC
$10b - $20b – split 90/10 between the government and BAC
$20b - $38b – all BAC
$38b - $118b – 10% BAC, the other 90% through a Fed non-recourse loan to BAC
In exchange for the asset guarantee, BAC will issue $4 billion of preferred stock with an 8% dividend and warrants for $400 million of common stock. The term sheet doesn’t specify the strike price, but it's $13.30 in the other part of the deal and I assume it’s the same here.
The capital purchase part of the deal is simpler. The government is paying BAC $20 billion for $20 billion of preferred stock with an 8% dividend and warrants for $2 billion worth of common with a strike price of $13.30 per share.
Summarizing: BAC got $20 billion in cash and a loss backstop on a bunch of assets in exchange for $24 billion of 8% preferred stock and warrants for $2.4 billion worth of common, strike price $13.30.
The dividend on this preferred will cost BAC $480 million per quarter as long as it’s outstanding. Unlike the first round of TARP, the dividend rate on this issue doesn’t step up in five years.
In addition to the financial terms, BAC is not allowed to pay a dividend higher than a penny a share, has to abide by executive compensation limits, agrees to oversight on major corporate expenditures and BAC will track the use of the new TARP money. The asset guarantee terms include this provision “This template also will include, among other things, a foreclosure mitigation policy acceptable to USG.” That one could turn into a zinger for the bank depending on who determines what constitutes an acceptable foreclosure mitigation policy.
BAC was paying a 32-cent quarterly dividend on about 5 billion shares, or $6.4 billion a year. The total common stock dividend payout drops to $200 million per year under this deal. Add in the nearly $2 billion of new preferred dividend and BAC has cut cash outflow by roughly $4 billion per year. Not much comfort to income investors who were counting on the dividend stream.
I haven’t taken any kind of in-depth look at BAC, but would be very concerned about owning any bank that needed to make a second trip to TARP for help. The deal certainly improves survival prospects; providing $20 billion in cash, asset guarantees and a $4 billion net dividend payout reduction.
This deal is very similar to the terms for Citi’s second trip to TARP, so maybe we’re finally getting some consistency in how the government is handling the program.