RBC Capital Markets said the completion of initial debt exchange and sale of additional non-strategic assets will strengthen the balance sheet of Bank of America Corp. (NYSE: BAC).
"We believe the company is about half way through its planned exchange program, and it would like to complete these transactions by year-end. Since the remaining preferred issues are unlikely to be trading at such a deep discount, we are only projecting a total after-tax gain of $1 billion ($0.10 per share) for the fourth quarter of 2011," said Joe Morford, an analyst at RBC Capital Markets.
Amidst current market conditions, credit spreads have widened, placing a downward pressure on market values of Bank of America's debt and preferred stock issues, some of which are now trading below par.
The company's management is taking advantage of this anomaly by issuing up to 400 million shares of common stock (3.9 percent of outstandings) and $3 billion in new senior notes to effectively replace roughly $6 billion of higher-cost preferred stock and/or trust preferred capital debt securities.
The company announced the completion of the first round of these exchanges, including the related issuance of 185.5 million shares of common stock (1.83 percent of outstandings) and $998.1 million of senior notes, on Thursday.
The company's management expects to complete all proposed exchanges before year-end 2011, generating about $1 billion after-tax gain (about $0.10 per share). Ultimately these exchanges are expected to add 25 basis points to the Tier 1 common capital ratio, while the reduced interest and dividend expenses should offset some of the EPS dilution.
Separately, since the third quarter of 2011, Bank of America sold most of its remaining stake in China Construction Bank (CCB) for an after-tax gain of about $1.8 billion ($0.16 per share), which together with some further realization of the deferred tax asset should boost Tier 1 common capital by 24 basis points.
Bank of America also sold its stake in the Pizza Hut franchisee, NPC International, for $755 million and reportedly sold another $50 billion of MSRs.
Finally, the previously announced sale of the Canadian card business is expected to close in the fourth quarter of 2011 at a modest gain. However, by freeing about $8 billion of risk-weighted assets it should add another 7 basis point to capital levels. As such, by year-end the company's Tier 1 Common capital ratio could be as high as 9.25 percent.
"We are also modeling roughly a 4 percent higher share count heading into next year, but the ultimate dilution to EPS should be mitigated by savings on interest expense and preferred dividends, which we estimate at more than $150 million after-tax ($0.01 per share)," said Morford.
The brokerage raised its fourth quarter EPS estimate for Bank of America to $0.42 from $0.12 and its 2011 estimate to profit of $0.25 from a loss of $0.05. However, the brokerage lowered its 2012 EPS estimate to $0.97 from $1.00.
"Adjusting for both the anticipated asset sale gains and the debt exchange, we are revising our EPS estimates. We recognize it will take time for BofA to return to more normalized earnings runrates, but we still see value in the shares at just 45 percent of tangible book, so we maintain our Outperform rating with Average risk with a price target of $10," said Morford.
Bank of America stock is trading down 3.11 percent at $5.60 in pre-market trading on NYSE.