How Much Further Can Bank of America Fall From Here
Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Financial giant Bank of America Corp. (NYSE: BAC) has suffered through rocky times and is trading around $7.29, with a 52-week high of $14.95 and low of $4.92. The company still has major issues it is combating. While the share price bounced off a floor at about $5.00 a share investors have to ask if it could it fall below this level? How much further can Bank of America fall from here?
This is a heavy question, since it has a market capitalization of almost $77 billion. For 2011, Bank of America reported $85 million of net income, or $0.01 per share. The company has set a goal of decreasing its operating expenses by $5 billion, but while core operating expenses have declined in 2011, they will fall far short of this goal. Asset quality has improved slightly, at least superficially with its ratio of nonperforming loans dropping to 2.74% in the fourth quarter of 2011, which was a mild but welcome improvement from the 2.87% of the third quarter.
BAC has three major problems. Two of those come from its acquisitions of struggling mortgage companies and portfolios during the banking crisis, especially as it deals with the Countrywide Mortgage legacy.
The purchase of Countrywide in 2008 gave Bank of America a host of toxic mortgages. The bank has taken somewhere north of $200 billion in bad asset write downs since 2007 off a $2 asset balance. Yet it is almost certain that a number of its assets are still painfully overvalued, perhaps to the tune of nearly $90 billion in the gloomiest of predictions. I stand along with many observers that Bank of America is really a "zombie" bank, one who really does not have enough assets to cover its business model but where regulators keep a knowing blind eye because it is "too big to fail." It is essentially robbing the future Peter to pay the present Paul to cover the wretched state of its asset quality.
While it can get by now, this window dressing on the books simply pushes the day of reckoning back. It needs a long term solution. Much of the banking industry is looking to the federal government to come along with a solution, but it is hard to see anything meaningful being accomplished in an election cycle. This means no long term solution will even be attempted until 2013.
The Countrywide legacy also carries a profusion of potential legal liabilities, amongst them are charges of predatory lending practices working through the legal systems of the federal government and a half dozen state judiciaries. Bank of America as well as several of its endangered peers have been in negotiations with a variety of state and federal prosecutors, but a newly announced congressional probe into the mortgage meltdown may endanger any agreement. No one is sure how high this legal liability can be measured although a conservative estimate would be $200 billion. It is a liability years, if not decades into the future.
But despite whatever final solution comes from the courts the immediate effect is on Bank of America's balance sheet. It is getting tough for Bank of America to get financing, and it desperately needs to overhaul $800 billion of its debt structure. Its expense on interest is a further drag on profits the struggling company does not need.
The final problem is simply in its size. Bank of America made the attempt to be everything for everyone by offering a wide array of products and services. It has so many divisions, each with different expertise and target markets, that it is very difficult and perhaps impossible to manage. The management structure is bloated and overhead is high, which is why the cost cutting campaign falling well short of expectations is so bitter.
Many companies have faced similar situations and have spun away divisions to release shareholder value. The trouble is none of the individual Bank of America units seem to be healthy enough to survive long on their own. The positive side is the company has a massive asset base from its depositors. It just does not seem able enough to overcome the myriad problems it has to take advantage of it.
The downside is limited, though, simply because of the existing political and regulatory climate that considers Bank of America too big to fail. I believe a future price in the $2.50-$2.75 range seems likely. A shorting strategy looks good with an entry above $5.75 so with the current share price of Bank of America looks like a good short right now.
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