Money in the Bank (of America)?
After mounting an impressive recovery of nearly 30% from its recent lows, Bank of America has some investors wondering whether a long-term bottom has been established, or whether further downside risk remains tucked away in the vault. With a close inspection of their latest earnings statement, and a look at their proposed acquisition of Countrywide Financial, let’s crack the vault and peer inside.
There’s no question that the 4th Quarter of 2007 was a tough one for Bank of America. After posting net income of $5.2 billion in the 4th Quarter of 2006, their gains plummeted to $215 million, or $0.05 per share for Q4 2007. The decline resulted almost entirely from a $5.3 billion loss incurred by “writing down” a portion of its debt related to the subprime crisis. By comparison, Merrill Lynch and Citigroup have each written down $20 billion or more to date.
2007 Writedowns (in Billions)
Merrill Lynch $22.4
Morgan Stanley $9.4
Bank of America $5.68
Deutsche Bank $3.2
Mizuho Financial $2.8
Total, top 10 $98.9
Overall Total $120.9 Sources: Company reports, WSJ
The Q4 earnings report offers some important insight into the bank’s remaining exposure to subprime mortgage CDOs (collateralized debt obligations). After the write-downs, Bank of America claims $8.18 Billion in remaining exposure to subprime CDOs, which seems like a finite sum which investors can begin to quantify. Of course, significant rises in the default rates on other debt categories (such as non-subprime mortgages, consumer credit, or home equity) could cause further losses to mount quickly.
Despite prevailing tightness in the credit markets, Bank of America posted significant increases in loans outstanding. From the prior quarter, they added $30 billion in consumer credit, notably in credit card and home equity lending. They added $55 billion to their commercial loans, focusing on domestic commercial loans and commercial real estate. These bold lending practices reveal that the company expects the U.S. economy to skirt a major, prolonged recession.
Speaking of bold moves, Bank of America recently announced it will acquire beleaguered home mortgage lender Countrywide Financial. Having invested $2 billion in the company back in August, it’s clear Bank of America has been eyeing Countrywide for some time. They’re paying 31 cents on the dollar based upon Countrywide’s “tangible book value”. In truth, however, there can be no ‘tangible’ book value until these mortgage losses show up on the books. Over the long-term, there are clear competitive advantages for Bank of America to acquire the country’s leading mortgage lender, but the short-term risks to Bank of America’s bottom line appear substantial. Admittedly, in a scenario where this financial slowdown is but a short-lived and well-contained hiccup, this deal will look very attractive for Bank of America.
What’s the foolish bottom line? Given the continued uncertainty facing the banking sector, the aggressive stance of management as predicated upon a bullish outlook, and substantial exposures to further losses in subprime and other securitized debt instruments, it looks as though the recent rally in Bank of America shares was premature, and that the January lows under $35 may well be re-tested or even new lows created.