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On August 29, 2011, Bank of America Corp. (BAC - Analyst Report) announced that it has socked a deal with a group of investors to sell about half of its stake in China Construction Bank (“CCB”) for approximately $8.3 billion. This is part of BofA’s effort to strengthen its capital position in order to reinstate dividend hike and meet new international capital standards.
The CCB stake sale has long been anticipated by the market. However, market turbulence in recent weeks made the deal uncertain.
Bloomberg data showed that the company is the second largest stake holder in CCB, the world’s second largest bank by value, after the 59% right held by the Chinese government. Following the divestiture of 13.1 billion of CCB common shares, BofA will still continue as a strategic investor in CCB withabout 5% stake.
The proposed Basel III standards set a ceiling of less than 10% stake in any financial institution. The reduction in the CCB stake would help BofA to readily comply with the requirement.
The deal, which is expected to close in the third quarter of 2011, is expected to generate an after-tax gain of approximately $3.3 billion during the quarter. The transaction is also likely to help the company generate about $3.5 billion in additional Tier 1 common capital and reduce risk-weighted assets by $7.3 billion under Basel I.
In 2005, BofA had paid $3 billion for a 9.9% stake in CCB, before CCB’s IPO. The company further raised its stake by exercising the option to purchase an additional 11% for $9.2 billion.
This is not the first time that BofA is selling its stake in CCB. In January 2009, the company had sold 2.5% holdings in CCB, reaping a profit of $1.1 billion. Further, in May 2009, the company sold another 9.9% stake leading to a pre-tax profit of $7.3 billion. Also, in 2010, the company sold its right to buy another 1.79 billion shares in CCB to Temasek Holdings Pte, Singapore’s state investment company.
Worries about BofA's ability to meet regulatory capital requirement and maintain profitability have significantly eclipsed the bank's stock price. However, the $5 billion investment made by Warren Buffett's Berkshire Hathaway (BRK.B - Analyst Report) in the company on August 25, 2011, was real a confidence booster.
Also, the market expectation is that BofA requires about $50 billion additional capital in the coming years to meet global capital standards. Amusingly, BofA has already generated about $30 billion from non-core asset shedding initiatives in the last six quarters.
The company hopes to fulfill the regulatory capital requirement through organic means, aided by the sustained paring of non-core assets. However, we speculate that the company would need to issue some shares to meet the capital requirement.
Besides fulfilling the capital requirements, BofA’s plan to sell its stake in CCB is part of its long-term strategy to remove non-core assets from its balance sheet as the company looks to concentrate more on businesses that directly serve customers, as well as fortify its balance sheet.
BofA has also broached talks with The Blackstone Group (BX - Analyst Report) to sell real estate assets held by its Merrill Lynch unit for nearly $1 billion.
Moreover, early this month, the company agreed to sell its Canadian credit-card unit to Toronto-Dominion Bank (TD - Snapshot Report) for $7.6 billion.
BofA also shed a number of non-core assets earlier this year as well as the last. Among others, BofA sold 43.6 million of its BlackRock Inc. (BLK - Analyst Report) shares for $163 each in November 2010. Furthermore, the company sold an additional 2.5 million shares of BlackRock to Japan’s third-biggest bank Mizuho Financial Group Inc. Also, in July 2010, BofA completed the sale of First Republic Bank (FRC - Analyst Report) for $1.86 billion to a group of investors led by Colony Financial Inc. (CLNY - Snapshot Report) and General Atlantic LCC.
Besides hiving off non-core assets, BofA is also planning to retrench 3,500 workers this quarter as the company is fraught with its $1 trillion problem-loan portfolio. Also, thousands of additional layoffs could ensue in the upcoming quarters as the company is working on a broader restructuring plan to recover its financial position. Though BofA is still deliberating about the extent of the job cut, the number might go beyond 10,000 as part of a wider review.
We do not see an end to this non-core divestiture in the recent future. With BofA’s plan to boost dividend in the second half of 2011 being turned down by the Federal Reserve in March, the company sees this as an inevitable way to shore up capital strength and fortify its balance sheet.
Currently, BofA retains a Zacks #4 Rank, which translates into a short-term Sell rating. However, considering the fundamentals, we maintain a long-term Neutral recommendation on the stock.