Bank of America, Inc (BAC) is the second largest bank in the United States, with some $2.2 trillion in assets. It was created when Nationsbank acquired BAC in 1998. Over the years, the combined organization grew mostly through acquisitions such as Fleet Financial in 2004 and credit card issuer MBNA in January, 2006. Things were going well. Fast forward a few years, and there is no company I would rather avoid investing in than BAC. Why? The single biggest reason is its purchase of Countrywide Financial in 2008.
BAC was trading recently at a little over $5 per share, within a few cents of its recently established 52 week low of $5.03. Its 52 week high is $15.31. It has a market capitalization of some $54 billion, and no P/E as it has lost money the past twelve months. It pays a dividend of a penny per quarter, for an annual yield of 0.80%.
In the third quarter, BAC stated net earnings of $6.2 billion, or $0.56 per share. But that was almost solely due to one time occurrences. There was a $4.5 billion positive adjustment on structured liabilities, and another $3.2 billion gain from the sale of a Chinese unit. Add in the other smaller credits and subtract the one time deductions, and reduce that total from the $6.2 billion, and one ends up with pretty much $0 earned from traditional commercial banking and investment banking activities. Its Tier One Capital ratio is 8.65%, lower than the other “money center” banks; Wells Fargo and Company (WFC) (11.28%), Citigroup Inc. (C) (13.5%), and JPMorgan Chase and Co. (JPM) (9.9%).
BAC purchased toxic mortgage guru Countrywide Financial in July 2008. Fundamentally, at the time BAC simply created a subsidiary of itself, moved all of Countrywide's assets into it, and transferred consideration of nearly $35 billion into the shell of Countrywide to cope with its liabilities. It is clear that the $35 billion is not enough to cover all the liabilities and lawsuits, so the only viable option is for the subsidiary to file for bankruptcy protection, therefore insulating BAC from further exposure beyond the $35 billion. However, if the integration between Countrywide and BAC has been too thorough, that strategy will fail. I hate uncertainty.
BAC seems unconcerned with growing. Its interest income in the third quarter has declined some $2 billion in the past year. BAC boasts of its $141 billion of new loan activity. But as a percentage of its asset base, that level (6.4%) of new loan activity pales compared to a growing bank like U.S Bancorp (USB), whose third quarter loan commitments equal 18% if assets, Rather than growth, BAC seems more concerned with reducing non interest expense. It has launched a plan, “Project New BAC” aimed at reducing annual costs by up to $5 billion by 2013. While reducing its efficiency ratio, currently at about 62%, is a fine goal, management has other issues with which to deal.
Many have pointed out that the esteemed Warren Buffett is on board as an investor in BAC. Not so fast. What Buffett did was acquire $5.0 billion of a special preferred stock guaranteed at 6% annual dividends. Buffett also acquired the right to purchase up to 700 million common shares for $7.14 per share. Before we claim that Buffett is a fan and supporter of BAC, look what Buffett has done with a few other recent purchases. Earlier this year, Buffett announced he had purchased some $10.7 billion in International Business Machines, Inc. (IBM) common stock. Buffett has also bought Intel Corp (INTC), Visa,, Inc (V) and other companies this year, investing in common stock. The simple fact that Buffett wanted to “dip his toe” into the BAC water via a preferred issue indicates less than sincere conviction in BAC's future.
BAC has exposure throughout Europe, but nearly $15 billion is to the most troubled economies such as Italy, Spain and Greece. It is embroiled in litigation on mortgages it sold, with an exposure of up to $12 billion, and the number continues to grow. Here is a typical description of the mortgage issues at play.
Last but not least, very recently S&P cut its debt ratings to dozens of large and money center banks in the United States and Europe. BAC, and its main units Merrill Lynch and Countrywide all had their ratings lowered. The dollars and cents damage to BAC by this decision is hard to gauge, but BAC has acknowledged any lowering of its credit rating could be materially damaging.
As if to prove the axiom that “every cloud has a silver lining” by at least one definition BAC is grossly undervalued at present. BAC's tangible book value at the end of the third quarter was $13.22 per share.
There are many other banks that are more worthy of investor dollars than BAC. For large money center banks, look to WFC or JPM. For “super” regionals, look to USB or PNC. BAC might have a lot of leverage at its deflated stock price and high beta of 2.9, but that leverage is best utilized only by the most speculative of investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
