Is BAC Taking More than its Fair Share of Blame?
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The report of quarterly earnings by Bank of America (NYSE: BAC) preceded a small rise in its stock at opening and a spike above $9 mid-afternoon. When the day ended, however, its stock was down, after opportunity for more analytical review beyond the headlines and sound bytes, which also heralded good quarterly earnings by the other big banks, including JP Morgan, Wells Fargo, Morgan Stanley, and Goldman Sachs, to add a feel good effect.
Bank of America had beaten the Street's expectations by posting earnings per share of $0.03, valuation adjusted $0.28. That expectation had been $0.12. Stripping out one time gains reflected in the $0.28 left a per share number between $0.17 and $0.18.
Questioning about reserve allocations dampened the initial ardor, however. The next day the stock was down more, even though several analysts had raised their targets for Bank of America's stock to $10 and above. During the next week, the price steadied a full dollar below the heights of March when anticipation of better environment for the financials going forward supported them, based on all but Citigroup (NYSE: C) having passed the Federal Reserves' stress test, and statements by the Regulators that Dodd-Frank, especially, the Volcker Rule would not be implemented any time soon. Thus would preserve profitable proprietary trading for yet a little while longer, and permit a more orderly disengagement when the end would come.
First quarter results reflected the favorable short-term consequences of selling off supposed non-core business and lopping off more than 30,000 heads in phase 1 of new CEO Brian Moynihan's Project New BAC. The loss of heads reduces salary obligations, offset somewhat by severance packages and other soft landing devices, but it also reduces the garnering of new business and the capacity to handle it once it arrives. In other words, it tends to reduce future earnings.
I have another, more serious, perception of what is affecting Bank of America, however. The reserves for all those non-performing loans acquired primarily from Bank of America's Countrywide Financial acquisition may not be adequate. Even current earnings may be overstated as a result of under reserving. The actuaries are a pretty studious and circumspect lot, but even they have leeway. Bad recovery outcomes and the claims against Bank of America of securitized buyers and their insurers will cause direct hits to earnings. Rigorous actuarial analysis of those outcomes and claims will be reflected in reserve calculations, further reducing present and future earnings.
Bank of America has already booked $42 billion of losses due primarily to Countrywide's subprime portfolio. Yet Fannie Mae is still knocking on the door, so far demanding another $16 billion. When Bank of America refused to open that door, Fannie Mae cut off new loan funding. This is not as dire as it seems because Bank of America was cutting back anyway.
Bank of America has already dropped its mortgage origination business by about half. More importantly, Bank of America is concentrating its focus for that business on residential loans to its traditional banking customers. Its target is to eliminate purchasing loans from others. "Direct-to-retail,” CEO Moynihan calls it.
Beyond that, what can Bank of America do to change this potentially debilitating perception and prevent it from becoming reality?
In my opinion the subprime fray is inevitable. If it cannot be avoided, my suggestion is for Bank of America to cause everyone to join in. If the invitation results in litigation, and inevitably, I believe it will, so be it. Indeed, having been rebuffed at BAC's door, Fannie Mae is already heading toward the courthouse one.
Bank of America may be the least culpable, and the least responsible of those Bank of America should invite to the fray. It acquired Countrywide, the source of subprime lending. Before that its own portfolio would have been the typical bank customer based lending that Moynihan wants to get back to.
Perhaps, Bank of America should have been more diligent in its due diligence when it acquired Countrywide. But there is plenty of fault beyond that to go around for the subprime crisis. Its impetus was political. The mantra was "a home for everyone." Its chief instigators were Congress and the government sponsored Fannie Mae and Freddie Mac. They should be included in the fray. Realistically, the politicians cannot be held more accountable for their instigation and support of policies than their defeat in the next election. But let that be. It is legitimate for the point to be made, even by Bank of America. As for the governmental entities, they can be affected by litigation holding them responsible, by limitation on their activities going forward, and by defeat of their efforts to hold others, such as Bank of America accountable for more than is their due.
Those brokers and agents who provided automatic loan applications and those applicants who provided no documentation of ability to repay the loan should be included in the fray. Of course, those brokers and agents were merely offering a product prepared by others which they had authority to offer, and which generally was deemed desirable to do at the time. Without verifying documentation, what misrepresentations could applicant providers be making to hold them liable? Nevertheless, they were beneficiaries, along with Bank of America, so their commissions may be subjected to the same recoveries that are being sought against Bank of America.
The home buyers who accepted the loans were merely responding to a deal too good to be true. Are they to be faulted for that? Whether or not, they are suffering the consequence in the loss of their homes as they fail to make their loan payments. Traditionally, they may also be tagged with the costs of foreclosure.
Those who purchased the securitized loans and therefore the funding and liquidity necessary to support the sub-prime market should also be included. What good is insurance if the insurers do not pay the claims when they are presented? Every one of these is culpable and responsible to their varying degrees.
Bank of America should not be singled out. It should not bear the brunt. As the occasion arises, in negotiation or litigation, it should assign the defaulted home or mortgage to Fannie Mae, or whomever else would seek recompense of it, subject to whatever claims others may be asserting against Bank of America.
Meanwhile, Bank of America should establish its reserves as positively as it can within the constraints of what the actuaries will permit, and get on with its banking, investment advisory, and other core business, including its proprietary trading, as long and as profitably as it can.
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