Even if default rates soar in China, as one could reasonably expect given its economic issues, investors in Bank of America can take solace in the fact that the Charlotte, North Carolina-based bank has dramatically reduced its exposure to the Asian country over the past few years.
Concerns about China came into focus on Tuesday after its central bank reversed its years-long exchange-rate policy by devaluing the Yuan. The move is particularly troubling to non-Chinese banks that have made dollar-denominated loans to Chinese corporations. This is because the cost of servicing those loans increases in proportion to the extent of devaluation.
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Let's assume, for example, that XYZ Corporation, a Chinese company, borrows $100 million from Bank of America at an annual interest rate of 7%. Before Tuesday's devaluation, XYZ Corp.'s annual interest expense would cost it 42.8 million Yuan. After Tuesday's devaluation, the cost increases to 43.6 million Yuan.
This alone probably won't trigger widespread defaults, as the increase amounts to only 1.8%. But it could hurt on the margin, and particularly at highly leveraged companies that are already having problems making ends meet.
The good news for Bank of America's shareholders is that, while the bank has lent money to borrowers in China, it long ago shed its most significant exposure to the country: its substantial ownership stake in China Construction Bank. At its peak in late 2008, Bank of America owned nearly 20% of China Construction Bank. Over the next three years, however, it whittled this down to less than 1%, raising nearly $23 billion in desperately needed capital along the way.
The nation's second biggest bank by assets is left with roughly $12 billion in total exposure to China. This is split between funded loans ($9.8 billion), unfunded loan commitments ($385 million), net counterparty exposure ($691 million), and securities or other types of investments ($1.3 billion).
Ideally, Bank of America wouldn't lose any money on any of these assets. But if it does lose a small fraction, which seems reasonable if things continue in the direction they're going, I would guess that the impact isn't likely to materially impair the $2.2 trillion bank's earnings.
The article In Hindsight, Bank of America's Decision to Sell Its Stake in China Construction Bank Was Brilliant originally appeared on Fool.com.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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