Stocks had a surprisingly good day after a report showed stronger U.S. factory activity and also apparently becasue Spain signaled it might ask for a bail-out (which, for whatever reason is apparently a positive thing).
Stantec was particularly strong up 3.9% to $34.82. It’s a long-term winner.
Bank of America was up 1.5% despite announcing on Friday (after the close, I believe) that it would pay $2.4 billion to settle a class action lawsuit regarding its Merrill Lynch Division. The fact is that $2.4 billion (pre-tax) is simply not that huge for Bank of America which has a book value of $235 billion. The market has reacted positively because the settlement reduces uncertainty about this liability.
And this brings me to address the topic of Bankruptcy and how the “death” of Bank of America and all the big U.S. banks has been greatly exaggerated.
For the past few years, even after they were bailed out I have read countless claims that all the big American banks were broke and worthless and insolvent if they were honest and marked their assets and liabilities to market. The implication being that a bankruptcy announcement is forthcoming and that one should certainly not buy their shares.
I won’t dispute that some of the banks might have had a negative net worth on market to market basis. But that did not mean they were necessarily worthless or that they were about to go bankrupt.
Banks are generally profit generating machines. Even is they have a negative net worth due to some unusual crisis, they will generally recover if left alone. Basically you just let them sit there and keep the machinery turning and they will crank out profits to rebuild equity. This is in fact what has happened.
In general corporations do not necessarily get forced into bankruptcy just because their net worth falls below zero. They may get forced into bankruptcy but this negative net worth alone is not sufficient to cause it.
In general all three of the following conditions must be met before a corporation would be forced into bankruptcy.
- It is making losses and as a result runs out of cash to pay its bills
- It does not have assets that it can sell off to raise cash to pay the bills
- Its lenders refuse to lend more money or they call in the existing loans.
As long as lenders keep lending money a corporation can go on for a very long time with a negative net worth on the balance sheet and with annual losses. If lenders believe it its future and continue to lend the company money to pay iots bills then it has no reason to go bankrupt.