Why You Should Sell Bank of America

| About: Bank of (BAC)

By Jack Barnes

Bank of America Corp. (NYSE:BAC) is one of the largest banking complexes in the United States. But its strategy of growing through acquisitions has left the company terribly vulnerable to an economic downturn. That's why it's time to sell BAC.

Complete disclosure: I worked for Bank of America as a teller 20 years ago, so I have a slight bias. I want that to be clear upfront. Still, when I was a hedge fund manager in 2008, I had shorts on BofA and a slew of other financial companies. And when I heard about Bank of America's takeover of Countrywide Financial, I was shocked to the point of giggling.

Since then, the Countrywide merger has been like a cancer eating away at Bank of America's very core. But that's not the only headwind facing the company. In addition to the Countrywide debacle, which gives BofA greater exposure to the housing downturn, the company also is facing a raft of legal troubles.

A House of Cards

Over the past several years, Bank of America has relied on mergers and acquisitions for growth, and now many of the businesses the company absorbed are struggling with economic conditions tougher than expected.

BofA has grown into one of the largest owners of private homes in America due to massive amounts of foreclosures. This leaves the company open to additional declines in housing values. Robert Shiller, the economist who co-founded the S&P/Case-Shiller index of U.S. home prices, said just last week that a further decline in property values of 10% to 25% over the next five years would not be surprising.

"In real terms, there has never been a bust of this proportion," said Shiller. "Even in the Great Depression, home prices fell nominally approximately almost as much as they did recently. But that was with all prices falling. So real estate prices didn't go down hardly at all during the Depression."

There simply is not enough demand to keep homes at the prices at which the banks are still carrying them, and this situation will be compounded if the U.S. economy experiences a double-dip recession.

I firmly believe any additional weakness in home values in the United States will disproportionately impact the strength of Bank of America's balance sheet. This will put the company at a disadvantage in the future, when growth returns to the economy.

And that's not all. Bank of America stands accused of operating as a robo-signing foreclosure factory. Now federal judges are starting to demand additional levels of documentation on foreclosures. If the company loses these cases -- and there are a growing number of them -- the downside risk increases.

Finally, a growing number of lawsuits accuse Countrywide of out-and-out fraud when it was packaging and marketing mortgages to sell to sophisticated investors. Some of the largest investors in the world are starting to join together to demand that Bank of America take back loans sold during this era.

In the fourth quarter of 2010, Bank of America set aside $4.1 billion for legal costs tied to home loans it was buying or was likely to buy back from investors. So all of these legal battles are just getting started.

I usually like extreme value investments, but Bank of America is a value trap. Its balance sheet will have to absorb more losses as housing prices continue to drop in the United States. And these legal troubles could set the company back even further.

The stock currently trades near its 52-week low of $10.49.

Disclosure: None

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