BAC Problems
Research for Online Investors

by John Dalt

8/29/11

Personal Income numbers came out this morning from the Bureau of Economic Analysis.  Incomes grew at a 0.3% rate, this was below expectations of 0.2  Personal Spending increased 0.8%, this was the highest growth in spending recorded since the October 2009 report.

News out this morning that Bank of America (BAC) is selling 13.1 billion shares of China Construction Bank (CCB) for $8.3 billion in cash.  This represents about half of BAC’s shares in CCB.  This comes on top of the Berkshire Hathaway investment in BAC of $5 billion last week.  Why does BAC need all this money?  Investors and traders took the company’s stock to the woodshed last week before Buffett put money up on a “vote of confidence.”

BAC’s problems are traceable to the company’s purchase of Countrywide Financial back in January 2008.  Countrywide was the nation’s largest mortgage company.  Within months of buying Countrywide, the real estate mortgage crisis turned Countrywide into one of the biggest blunders in banking history.

Within fourteen months, BAC had taken $45 billion in TARP funds from the U.S. Treasury.  They had repossessed $1.7 billion dollars in real estate and were carrying it on their books.  In the last two years they have worked to clean up the Countrywide mess, but now they are carrying $3.9 billion of repossessed real estate on their books.  They have another $20 billion in home mortgages that are in process…to foreclosure.  BAC is the largest U.S. private lender with a total book of $450 billion in real estate loans.  $400 billion of these mortgages are on residential real estate.

Home prices were down 5.9% in the second quarter and Pending Home Sales for July came out this morning, they were down 1.3%  Home prices keep falling which makes the bank discount foreclosed property to make a sale.  Discounted prices bring down other home prices putting pressure on existing homes and mortgages and creating more foreclosures.  BAC is caught in a vicious cycle of foreclosure, discount, foreclosure.

Business Insider explores the numbers on Bank of America (BAC).  They believe the bank is underreporting the number of mortgages in trouble.  $20 billion in non-performing loans (and the resulting loan loss reserves) is only 5% of the $400 billion in residential loans.  Securitized mortgages are running a 30% non-performing rate.  The OCC/OTS says 20% of all loans were in some stage of non-performance at the end of the first quarter.  BAC may have some of the best mortgages, but 5% compared to 20% or 30% for industry wide statistics seems suspect.

Banks like to keep the best loans on their books rather than securitize them.  This also gives them the advantage of not having to “mark to market” on these loans.  Securitized loan packages have to be marked to market, whole loans are carried at the price they are acquired.  Only if they are classified as “non-performing” does a bank have to set aside money in the loan loss reserve.

The analyst in Business Insider questions whether BAC’s whole loan book of residential loans are better than the statistical model, and believes they may be the worst loans.  His reasoning is that the market has been slow for the last two years, so many of these loans were made at the height of the housing bubble just as the securitization process was breaking down.

If true, these whole loans would be at pre-crisis housing prices and should be experiencing higher delinquencies than the statistics model.

BAC has $17 billion exposure to European debt and $67 billion in net “derivative” assets as of June 30, 2011.  Total derivative exposure is $1.9 trillion.  BAC’s shareholder equity, or book value, is $230 billion.  With all the charges and exposure on BAC’s $2.2 trillion balance sheet, this $230 billion does not look very conservative.  Higher loan losses, a ripening eurozone crisis or a blow-up in derivatives could wipe out their equity.  We do not own any BAC stock.

The market looks like it wants to rally today.  The Europeans are fighting over providing Finland collateral on their loans to Greece.  Be cautious, the headlines from across the pond foretell more problems ahead.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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