Investment banks not safe yet
For those thinking that maybe it’s a good time to start playing around with investment banks since their depressed pricing must mean there’s some value in there, today’s news on Merrill Lynch’s firesale of $30.6 billion in bonds for just 20 cents on the dollar along with plans of yet another equity offering has to raise alarm bells.
First and foremost, the $30.6 billion in bonds were valued by management at 55 cents on the dollar at quarter end (6/30/2008). How in the world have they lost yet another 50% of their value in just one month? If management can’t even figure out how to value their assets, do investors even have a chance?
Investment banks’ profit models depend on high leverage - borrowing money to buy money making assets. It’s clear that that model is now broken and the assets that were purchased on borrowed money may never pay back. Firms are being forced to sell new stock in hopes of raising equity capital just to keep afloat which will continue to dilute value for shareholders. With new debt/equity capitalization and continued pressure on risky assets, the good times and fat profits from the last few years may be a thing of the past. What’s more, calling the bottom will be very difficult indeed.
I realize that I recommended Bank of America which, over the last few years, has morphed into a quasi-investment bank in the same way that many financial firms have attempted to capitalize on the boom in the investment banking industry, but ultimately Bank of America’s lack luster investment banking performance makes it a pretty different play than the traditional, investment banks which made their profits levering their businesses and buying risky assets. For more on my Bank of America investment thesis, check out the post on my BAC purchase in March.
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