By Steven Edwards
Recently, the U.S. attorney for Manhattan filed suit against Bank of America (NYSE:BAC) alleging that its subsidiary, Countrywide Financial Corp, systematically generated "thousands of fraudulent or defective loans" that were sold to those hapless federal wards, Fanny Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC). This was just the latest in an endless stream of litigation that the nation's largest bank has endured.
Bank of America used to be your friendly neighborhood bank, with most of its branches in sunny California suburbs. But it has grown to its current behemoth status by a series of acquisitions, including two that it should never have done: Countrywide and Merrill Lynch. The purchase of Countrywide Financial and Merrill Lynch by Bank of America during the run-up to the 2008 breakdown in the mortgage markets has left the bank with a long-term legacy of legal problems that still festers. Meanwhile, the company is shedding business and ceding its once pre-eminent position in the mortgage markets to Wells Fargo (NYSE:WFC).
Former Bank of America CEO Ken Lewis led the acquisition of Countrywide in January, 2008, at the beginning of the subprime mortgage debacle. "Countrywide presents a rare opportunity for Bank of America to add what we believe is the best domestic mortgage platform at an attractive price and to affirm our position as the nation's premier lender to consumers," said Lewis at the time. Four and a half years later, Lewis is long gone, and the legal fallout continues.
Merrill Lynch was also acquired by Lewis in 2008, at about the time that Lehman Brothers was filing for bankruptcy. "Obviously Merrill is much, much more than an investment bank. It is the best wealth management company in the world," said Lewis. It was also the biggest retail stock broker in the world, and Bank of America snagged it just as retail investors began abandoning the stock market in droves. Trading losses were also higher at Merrill than Bank of America had apparently realized. A class action lawsuit in regard to the acquisition was settled recently at cost of $2.4 billion.
Bank of America's recent quarterly report showed diluted earnings of zero per share, which is better than losing money, if you really believe that the bank is not losing money. Both interest and non-interest income declined from the year earlier quarter, with revenues down about $8 billion, or 28%. Bank balance sheets are subject to a lot of manipulation, because there are always loan loss reserves, and in the case of Bank of America, reserves against legal liabilities. But while the company booked credit losses of $1.7 billion (versus twice that much last year, at $3.4 billion), it reduced reserves by a much greater $2.3 billion. This, even as "rep and warranty" claims climbed $2.8 billion, for a total of $25 billion. The hope seems to be that the bank can settle everything for pennies on the dollar. Management is also cutting employees, most recently announcing a 16,000 cut in the payroll.
It is surprising, perhaps, that Bank of America is still number five on the list of stocks most favored by hedge funds, with Bruce Berkowitz's Fairholme fund being the largest holder. Uber-investor Warren Buffett, also, famously made a $5 billion investment in Bank of America last year through Berkshire Hathaway, but Buffett got preferred stock and warrants not available to the normal investor. B of A gave away a lot, just for the comfort that having Buffett along gave other investors.
Buffett and his billionaire buddies are counting on the fact that Bank of America still has some tremendous assets, including $1 trillion in deposits and bank branches all around the country. Merrill Lynch is still a formidable stock broker, although it now has to compete with strong online competitors like Charles Schwab (NYSE:SCHW), TD Ameritrade (NYSE:AMTD), and Interactive Brokers. Bank of America still is a major player in the mortgage markets, but whereas it once was first in the country, it is now fourth, after Wells Fargo, J.P. Morgan Chase (NYSE:JPM), and U.S. Bancorp (NYSE:USB).
Maybe the hedge fund managers see Bank of America as a value play. Its current stock price of $9.85 is less than half of its book value. But to arrive at an accurate value for any bank is difficult, to accurately value a financial company whose assets are constantly shrinking while its legal liabilities continue to mount is an impossible task.
This is not a stock that retail investors should toy with. There are too many imponderables, too many routes to the next crisis. The bank was terrifically mismanaged by Ken Lewis and though current CEO Brian Moynihan has gone in an opposite direction, necessarily shrinking the bank's assets to pay off legal claims, there is no evidence that real profits that don't rely on accounting tricks are in the bank's near-term or even long-term future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: This article is written by a contract writer and edited by me. We don't receive compensation for it other than from Seeking Alpha. We have no business relationship with any company whose stock is mentioned in this article, no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.