BofA to Repay TARP (in Part)

Bank of America Corporation (BAC - Analyst Report) intends to pay back some of the bailout money it has received from the government in its participation of the Troubled Asset Relief Program (TARP).

The government is also pushing the bank to pay at least $500 million to conclude a tentative pact in which the government agreed to share losses on certain BofA assets.

The completion of the payments would enable BofA to reduce a part of the government's involvement in its affairs.

Some of the large financial firms that have already repaid government fund are Morgan Stanley (MS - Analyst Report), Bank of New York Mellon Corporation (BK - Analyst Report), Goldman Sachs (GS - Analyst Report), U.S. Bancorp (USB - Analyst Report), American Express Company (AXP - Analyst Report), BB&T Corporation (BBT - Analyst Report) and State Street Corporation (STT - Analyst Report).

The repayment of government money can be viewed as a sign of recovery of the institutions as well as the economy. Also, the full repayment of government money has enabled those firms to keep from having their executive compensation packages reduced. Restrictions on the pay rules as a result of absorbing government money were major competitive disadvantages for those firms trying to retain talented employees.

However, unlike the other banks, BofA does not intend to repay its entire $45 billion support from the TARP at this point. But it may start with the repayment of $20 billion of additional aid it had received in January to absorb investment bank Merrill Lynch & Co.

In addition to the TARP money, in January the government agreed to absorb a major portion of losses on a $118 billion pool of assets owned by BofA and Merrill. The bank would issue $4 billion in preferred stock to the Treasury carrying an 8% dividend in exchange for this protection. Total cost to the bank for this deal would be about $320 million a year. Also, the bank would pay $236 million to the Federal Reserve.

We think that Bank of America is in a relatively good shape from a capital perspective. During this delicate period of market stress, the availability of significant private-sector capital is very limited. As a result, the management remains focused on managing asset-levels efficiently, ensuring the deployment of TARP funds to core lending businesses and trimming other assets in non-core businesses.

We think that the management is quite confident about its capital position as it has indicated it will pay back a portion of TARP funds.

We anticipate continued synergies from the company’s large-scale operation and balance sheet restructuring, but higher credit costs and worsening credit quality will be a drag on upcoming results. Therefore, we are recommending the shares as Neutral.

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