You know a bank is on the defensive when it responds to a popular blogger in a manner that falls short of professionalism while nevertheless making some good points. Is this a sign that it has lost control of its press? 

According to a recent Bank of America statement (as reported by the media): "Mr. Blodget is making ‘exaggerated and unwarranted claims,' which is what the SEC stated publicly when he was permanently banned from the securities industry in 2003."

Now that last bit about Blodget being banned from the industry was not necessary, and certainly in this context, it does little to advance an important debate. The part about "exaggerated and unwarranted," however, strikes me as fair use of adjectives in a rebuttal. 

Recall that Henry Blodget wrote an article that built on some calculations from the well known bloggers at Zero Hedge. Blodget essentially aggregated a lot of write-down exposures--mortgage litigation, second liens, commercial real estate, goodwill, exposure to Europe--and came up with total exposures in the $100 billion to $200 billion range. He compared that to the $222 in book value.  He perhaps set the wrong tone and waved some red meat in front of the Bank of America folks by claiming that the bank would also have to raise capital by $100 to $200 billion. 

Bank of America contests the accuracy of some of Blodget's numbers, which is fair enough. And a $200 billion capital raise does seem gargantuan. Analysts at Jefferies have said that the necessary capital raise would more like $40 to $50 billion. The company's view of course is that a capital raise is not necessary. 

So who is right? 

To start to answer that, we should dispel the myth--which seems to be prevalent right now--that a falling common stock price erodes the bank's capital position. In fact, it does no such thing. The standard definition of Tier 1 capital is common stock plus retained earnings. But the valuation of the common stock for capital position calculations is the value at original issuie. Once the stock has been issued and the proceeds retained by the bank, the bank's capital position does not vary as the stock trades on the open market. So while issuing new shares will allow the bank to build capital, a falling common stock price does not erode capital. 

When discussing Bank of America's capital raise prospects, the more salient issue is retained earnings. An increase in earnings--organically via operations and via asset sales--leads directly to a capital position increase. Bank of America officials have consistently said that in their view they will be able to grow earnings and continue to sell non-core assets (not Merrill Lynch), which will make issuing more shares unnecessary. 

But if the bank is forced to write off against the exposures outlined by Blodget, that will lead a decline in earnings. That is where the capital position pressure comes from. 

As of now, it appears that the bank has a lot of assets it could sell, and that might make up for some big looming write offs. At some point, if it had to, it could even resort to selling Merrill Lynch. My sense is that it will do whatever it takes to avoid a dilutive capital raise. Its float is large enough. At the same time, it's reasonable to conclude that the bank may not be successful in this delicate dance. At that point, it may have no choice but to issue shares. While $200 billion seems high, a more modest amount is possible. The Jefferies analysis may be more on point. -Jim

In any case, it would behoove Bank of America to lift the debate to a more professional level.