Friday's story in Bloomberg (click here) regarding Bank of America (BAC) highlights possibilities for money losing Countrywide, and pointed out what we have felt for some time (Bank of America: Rumors Provide Rare Opportunity). BAC does have an option of bankrupting Countrywide, and thus ending their legal liability for the troubled mortgage unit. BAC has paid over $30B so far to write off bad loans and settle many types of claims against their unit, purchased just prior to the start of the Great Recession.
From Bloomberg:
Countrywide has $6.53 billion of debt outstanding, including $2.81 billion of senior unsecured notes, $2.2 billion of preferred securities and $529 million of mortgage-backed bonds, Bloomberg data and Bank of America figures show. The unit’s $1 billion in 6.25 percent notes have plunged 9.2 cents since Aug. 1 to 97.1 cents on the dollar as of Sept. 13, according to Trace, the bond price reporting system of the Financial Industry Regulatory Authority.
Negotiating Tactic
Almost all of the damage to BAC's credibility has been due to their Countrywide sub. Management of BAC has taken all the heat for the tens of billions of losses embedded with that purchase, when they could just put Countrywide into bankruptcy (at anytime). So why would BAC continue to eat tens of billions of dollars, and let the market discount their market cap roughly $50B from the tangible book value? When things don't make common sense, there is usually a hidden reason (but discovered much later in time).
While waving the white flag might be tempting, and ultimately come to pass, we believe the real objective of this 'leaked' public revelation is to give cover for a global settlement for ALL the large banks. JP Morgan (JPM), Citigroup (C), and Wells Fargo (WFC) also have similar issues, but compared to BAC, their troubles have been relatively muted. We believe BAC is "setting the bar" for the other major banking institutions by globally settling the mortgage and underwriting issues because they are best positioned for it. A look deeper into the issue reveals that BAC is actually in the "best negotiating position" because Countrywide's problem mortgages are so large relative to Bank of America's legacy loans. BAC could bankrupt Countrywide and write off $8.5B (their $2B investment plus $6.5B of guarantees) if negotiations/litigations fail, whereas the others don't have that luxury since their legacy mortgages are a far higher percentage. For example, in the latest suit by FHFA, JPM's portion was $33B versus less than $2B from BAC itself. In other words, because BAC is best positioned to walk, they carry the biggest stick when creditors push too hard for a pound of flesh.
Armageddon Off The Table
Until this leak, it was difficult to glean what the banks were up to. Many bearish analysts have argued the company is going bankrupt over the legacy loans, and while crazier things have happened, it was tough to refute without an explanation from management of the legal options. A reasonable person would have thought that the largest bank in the world would have structured the purchase of Countrywide as an asset purchase and keep it as a subsidiary. However, until today we didn't know exactly what BAC's options were.
While the article points out the messiness and potential loss of credibility BAC would endure by taking the "nuclear option" of bankrupting Countrywide, it is nothing when compared to filing for bankruptcy for the parent. In fact the market is so negative right now, BAC could place $30B MORE into a legacy asset fund, walk away from Countrywide, and still come out ahead of where the market anticipates they are. The mere fact that BAC can walk is enough justification for the market to reassess the worst case scenarios. In other words, the $50B haircut the market is making is an overreaction, and there will be no shutting down of America's largest bank.
While we have always believed Armageddon was not an option for any of the large banks (2011 Is Not 2008: Why Lehman Was The Last 'Lehman'), we now have a bit more confirmation for that opinion. We also believe this bodes particularly well for both JP Morgan and Citigroup, as both of those institutions will definitely benefit by tagging along with BAC's trailblazing maneuvers. With BAC's option of walking from the situation, all creditors have far more reason to settle, thus the bar will be set at what is being offered (versus what is being demanded).
The stocks of the largest banks might take some time to digest the staggering amount of possibilities, and therefore move sideways for a couple of months. However, we would imagine that as the year wears on the settlement negotiations will escalate. While the total amount of money eventually paid out will be gargantuan, we now know that Bank of America will still be standing when its all wrapped up. In addition, a Lehman-like death spiral will not drag Wells Fargo, JPMorgan, and Citigroup (plus the rest of the civilized world) into the stone-age, and our crafty bankers will prove again why they are at the tip of the spear.
Bank of America (BAC)
- Price: $7.19
- Market Cap: $73B
- Now tangible common equity $128B from $62B 2008
- After writing off $95B in loan losses since 2008
- Still have loss reserves of $37B.
Citigroup (C)
- Price: $28.99
- Market Cap: $85B
- Now tangible common equity $142B from $30B 2008
- After writing off $90B in loan losses since 2008
- Still have loss reserves of $34B.
JPMorgan (JPM)
- Price: $33.43
- Market Cap: $130B
- Now tangible common equity $127B from $94B 2008
- After writing off $74B in loan losses since 2008
- Still have loss reserves of $29B
Wells Fargo (WFC)
- Price: $24.95
- Market Cap: $132B
- Now tangible common equity $92B from $65B in 2008
- After writing off $56B in loan losses since 2008
- Still have loss reserves of $21B.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
