Bank of America’s 10K

Blog readers should understand that I am a backtrader – this means that I do more work on my investments after events are realized, in self-flagellation and punishment, than I do before I actually put the money to work.

There is one trade that is, for me, particularly haunting.  This is Countrywide Financial Group, CFC.  During the third week of August 2007, Countrywide’s stock was on its way to zero, and I was supposed to make about three or four million dollars from a monster short position that combined written calls, near at-the-money puts, long-dated out-of-the-money puts, and short stock.  Instead Bank of America invested $2billion in the company and CFC briefly hit 27 in after hours trading.  I was forced out of large parts of the position and ended up breaking even on the entire trade (which started in early summer) and losing a ton the week of the BofA investment.

Having gone through this experience, there are few things that incite me more than pictures of Ken Lewis’ face.  I truly believe him to be the dumbest man ever to head a major American corporation.

Bank of America has become, forever in my opinion, America’s bank.  BofA is the true zombie bank that will only survive with substantial government help.  It is a burden of the state — whether the government bares the burden by taking direct ownership or by giving invisible subsidies (Fed purchases, near zero Fed Funds) makes little difference.

There are two silent bombs on BofA’s books at the moment.  First, there are a lot of bad loans.  Loaning to American consumers and businesses at a couple of points above the risk-free rate was just never a very good business, and BofA was particularly bad at it.

Second, BofA faces contingent liability for fraud.  Yes, just when you thought that financial companies were off the hook for all types of fraud, the legal system has come in and said, “You know those sh*tty mortgage bonds you sold to pension funds?  We think there was something not quite right with those transactions and we want you to buy them back near par.”

From BofA’s 10k: “We have been, and expect to continue to be, required to repurchase loans and/or reimburse the GSEs and monoline bond insurance companies (monolines) for losses due to claims related to representations and warranties made in connection with mortgage-backed securities and other loans.”

In plain English, this would read, “for losses due to misrepresentations.”

Countywide was in the business of misrepresentations (hence my short position in 07.  At one point I thought the fraud would be revealed in a few weeks — now we’re four years on, and we’ve uncovered about half of it), and the courts – to everyone’s shock – are now saying that if you sell bonds to someone on fraudulent terms, you might have to buy them back.

When BofA sold a mortgage bond to a private entity who then insured the bond with  a monoline insurer like MBIA, MBIA would rely on BofA’s documentation about the loans.  BofA might note, for example, that 90% of the loans in a particular mortgage bond are “owner-occupied housing”.  This is relevant because owner-occupied housing is less likely to default than investment properties.  The courts are now taking the position that if MBIA can prove that, say, only 15% of the homes were “owner-occupied”, this is fraudulent conveyance of the bonds on the part of BofA and BofA can be forced to compensate MBIA for the losses incurred in insuring the bonds.

Now, in next part of the post, we’re going to dig into the gritty detail, much of which is quoted directly from the 10K.  This part can be safely avoided.  I wish I could convey to you, dear reader, what goes through my head as I read these things.  And I wish I could understand why – given what goes through my head – I continue to read these things.

From the 10K: “On December 31, 2010, we reached agreements with Freddie Mac (FHLMC) and Fannie Mae (FNMA), collectively the GSEs, where the Corporation paid $2.8 billion to resolve repurchase claims involving first-lien residential mortgage loans sold directly to the GSEs by entities related to legacy Countrywide (Countrywide). The agreement with FHLMC extinguishes all outstanding and potential mortgage repurchase and make-whole claims arising out of any alleged breaches of selling representations and warranties related to loans sold directly by legacy Countrywide to FHLMC through 2008, subject to certain exceptions we do not believe will be material. The agreement with FNMA substantially resolves the existing pipeline of repurchase and make-whole claims outstanding as of September 20, 2010 arising out of alleged breaches of selling representations and warranties related to loans sold directly by legacy Countrywide to FNMA. These agreements with the GSEs do not cover outstanding and potential mortgage repurchase and make-whole claims arising out of any alleged breaches of selling representations and warranties to legacy Bank of America first-lien residential mortgage loans sold directly to the GSEs, loans sold to the GSEs other than described above, loan servicing obligations, other contractual obligations or loans contained in private-label securitizations. In addition, we have other unresolved representation and warranty claims from the GSEs and certain monolines, and other non-GSE counterparties, and certain monolines have instituted litigation against us with respect to representations and warranties claims.

We have experienced increasing repurchase and similar requests from non-GSE counterparties, including monolines, private-label MBS securitization investors and whole loan purchasers. We expect additional activity in this area going forward and the volume of repurchase requests from monolines, whole loan purchasers and investors in private-label MBS could increase in the future. It is reasonably possible that future losses may occur and our estimate is that the upper range of loss related to non-GSE sales could be $7.0 billion to $10.0 billion over existing accruals. This estimate does not represent a probable loss, is based on currently available information, significant judgment, and a number of assumptions that are subject to change. A significant portion of this estimate relates to loans originated through legacy Countrywide, and the repurchase liability is generally limited to the original seller of the loan. Future provisions and possible loss or range of loss may be impacted if actual results are different from our assumptions regarding economic conditions, home prices and other matters and may vary by counterparty.”

Now, let’s just read a Jan 2008 article on BofA/Countrywide in light of the above 10K.  My comments below are in all caps.

http://www.msnbc.msn.com/id/22606833/ns/business-real_estate/

Bank of America to acquire Countrywide

Deal for country’s largest mortgage lender valued at $4.1 billion

CHARLOTTE, N.C.  — Bank of America said Friday it will buy Countrywide Financial for $4.1 billion in stock, a deal that rescues the country’s biggest mortgage lender and expands the financial services empire of the nation’s largest consumer bank.

4.1 BILLION PLUS 2 BILLION CASH INFUSION IN AUGUST 2008, FOR A COMPANY WHOSE LIABILITIES EXCEED ASSETS BY OVER 10 BILLION

The acquisition will make Charlotte-based Bank of America Corp. the nation’s biggest mortgage lender and loan servicer.

Bank of America said it initially plans to operate Countrywide separately under the Countrywide brand, with integration occurring no sooner than 2009.

The transaction represents a 7.5 percent discount to where Countrywide shares ended Thursday after they soared on news that a rescue plan was in the works. It also effectively leaves Bank of America with a big loss on its $2 billion August investment in Countrywide Financial Corp. during the height of the summer’s global credit crisis.

An aggressive dealmaker who has already snapped up behemoths FleetBoston Financial and MBNA, Bank of America chief executive Ken Lewis this time isn’t buying a financial winner. Delinquencies and loans in pending foreclosure are rising in Countrywide’s loan portfolio, and Lewis said Friday “there are near-term challenges” in the nation’s housing market.

But Countrywide’s troubles have allowed Lewis to sweep in and add a major business line to his supermarket of financial products on the cheap.

“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,” Lewis said in a statement.

PLATFORM FOR FRAUD.  JOKE OF A PRICE, WOULD HAVE BEEN ZERO FROM SUMMER 07 ONWARDS IF GOVMT INTERVENTION WEREN’T PRICED IN.  “NATION’S PREMIER LENDER TO CONSUMERS”…. ALREADY POSITIONING HIMSELF AS AN ECONOMIC BEDROCK, IN NEED OF GOVERNMENT INTERVENTION.  YOU’VE AFFIRMED YOUR POSITION AS THE PRIMARY LENDER TO AMERICAN CONSUMERS, AN OBVIOUSLY SH#TTY BUSINESS.

It also places Lewis in the position of a market savior. By buying Countrywide, he’s keeping the industry and regulators from the messy task of figuring out who would take on the responsibility of collecting payments for the 9 million U.S. home loans serviced by the Calabasas, Calif.-based lender. Lewis said Friday there was no government support for Countrywide’s loan portfolio.

LEWIS SAID FRIDAY THERE WAS NO GOVERNMENT SUPPORT FOR COUNTRYWIDE’S PORTFOLIO…. ASSUMPTION: THE GOVM’T WOULDN’T TELL US, WE’D GET THE NEWS OF GOVMT ASSURANCES FROM THE PRIVATE DEALMAKERS (MEANING THE GOVMT ASSURANCES/SUBSIDIES GO TO PARTICULAR PARTIES, NOT TO ANYONE WILLING TO MAKE A DEAL).  BofA BOARD CALCULATION: $4B PLUS ANTICIPATED FUTURE LOSSES < ((GOVMT SUPPORT OF BOFA+COUNTRYWIDE)-(GOVMT SUPPORT OF BOFA))

“There’s still plenty of risk involved,” said Bart Narter, senior analyst at Celent, a Boston-based financial research and consulting firm. “He’s brave to do it. But I think that it’s very likely down the road to be profitable, maybe not immediately, but long-term.”

There was no immediate word on job cuts, but analysts said they expect some among the ranks of Countrywide’s 15,000 employees. Lewis said he would like Countrywide chairman and chief executive Angelo R. Mozilo to stay with the combined companies until the deal is done.

“Angelo has told me that he will do anything that we want him to do,” Lewis said.

I’M SHOCKED!!!

“I would guess that he’ll want to go have some fun.

HE WAS PLAYING GOLF AT BEL AIR EVERY DAY BEFORE YOU BOUGHT THE COMPANY

I will talk with him next week about his personal desires.

WHY DO YOU CARE?  AND BY THE WAY YOU’RE ALREADY THE BEST THING TO EVER HAPPEN TO HIM

Many of the senior people will have big operating roles in this company.”

WHAT??

Shareholders of Countrywide will receive 0.1822 of a share of Bank of America stock in exchange for each share of Countrywide. The deal is expected to close in the third quarter and to be neutral to Bank of America earnings per share in 2008 and lift earnings per share in 2009, excluding buyout and restructuring costs.

Bank of America expects $670 million in after-tax cost savings in the transaction, or 11 percent of the expense base of the two companies’ mortgage operations.

The agreement has been approved by both companies’ boards and is subject to regulatory and Countrywide’s shareholders approval.

Shares in Countrywide hit record lows in recent days on persistent rumors that a bankruptcy was imminent, a condition brought on by the widespread spike in mortgage defaults and foreclosures, especially in subprime loans — those made to borrowers with weak credit.

Countrywide shares plummeted more than 13 percent, or $1.04, to $6.71 at the open of trading Friday. Bank of America shares fell 19 cents to $39.11.

Countrywide shares have fallen 57 percent since Bank of America made its $2 billion deal in August at $18 per share. That purchase of preferred stock was convertible into a common shares of Countrywide at $18 per share, for roughly a 16 percent stake in the company.

Along with the $2 billion investment from Bank of America, Countrywide was forced to draw on an $11.5 billion line of credit to steady itself in August. It also tightened its credit guidelines and stopped selling some types of adjustable rate loans. But analysts said it wasn’t enough, with one noting this week that Countrywide needed an infusion of $4 billion in capital within the next two weeks to save itself.

Lewis’ bank holds $1.5 trillion in assets and is the nation’s largest bank by market capitalization.

“Their balance sheet can take a shock much better than Countrywide,” said CreditSights senior analyst David Hendler. “When you take the shocks at Countrywide, they have a big, busting consequence that’s negative.”

HAHA

While Lewis downplayed the prospect of a major deal last month, it fits with an established pattern of building Bank of America through acquisition. In the past few years, Lewis has expanded the bank’s retail operation with multibillion purchases of FleetBoston Financial Corp., bolted on a credit card business by adding MBNA Corp., and grabbed a wealth-management business in U.S. Trust Co.

The result of all the dealmaking is a widely diversified financial services company that does business with nearly one out of every two American households.

In the past year, Bank of America has boosted its market share of prime mortgages, or those offered to borrowers with a solid credit history, and was the top retail mortgage originator in the U.S. during the first nine months of 2007.

“We are aware of the issues within the housing and mortgage industries,” Lewis said. “The transaction reflects those challenges. Mortgages will continue to be an important relationship product, and we now will have an opportunity to better serve our customers and to enhance future profitability.”

MORTGAGES AS “RELATIONSHIP PRODUCT”…. THEY’RE TERRIBLE, BUT WE LIE ABOUT THEM AND SELL THEM TO SOMEONE ELSE.

In Countrywide, Lewis gets the “best, total mortgage-banking company in the U.S. by far,” Hendler said. Countrywide’s sophisticated back office is a valuable asset that makes Bank of America a much bigger competitor with Wells Fargo & Co., Washington Mutual Inc. and others, he said. In 2007, Countrywide had $408 billion in mortgage originations and has a servicing portfolio of about $1.5 trillion with 9 million loans.

NOTE TO SELF – GOOGLE DAVID HENDLER, AVOID ALL CONTACT.

“The technology platform, the people who run it, the hedging, the facilities, the mortgage servicing rights, the origination platform, you know, they are all state of the art,” Hendler said.

While there are some regulator hurdles to close the deal, they are hardly insurmountable.  IN FACT GEORGE W MIGHT TAKE YOU TO LUNCH The buyout would require approval from the Federal Reserve, and possibly other agencies, but analysts believe regulators are more concerned about a Countrywide collapse than industry consolidation.

A Countrywide failure would be a huge blow to government-sponsored mortgage finance companies Fannie Mae and Freddie Mac, which are major buyers of Countrywide’s loans.

NEVER READ….. XXXXXX WOULD BE A HUGELY POSITIVE DEVELOPMENT FOR FANNIE MAE AND FREDDIE MAC.

Federal law also bars banks from acquisitions that would increase market share above 10 percent of U.S. deposits, a limit that Bank of America is nearing. Bank of America chief financial officer Joe Price said because Countrywide Bank us a federally regulated thrift, it “doesn’t play into the deposit cap.”

In addition, banking industry experts say Bank of America could easily lower the total amount of money held in deposits by decreasing interest rates and shedding deposits.

58 Responses to “Bank of America’s 10K”

1. Martingaler says:

   March 12, 2011 at 10:29 AM

   Equity price movements (and many asset prices) are easily manipulated by large institutions with money and tons of hard to see self interests. Movements seem illogical because you didn’t know which way the wind was blowing when you bet. Btw the amount of garbage still at citigroup still dwarfs the crap purchased at bofa and has since 06. They were/are the real risk since they appear to be too incompetent to earn their way out before they have to revalue assets.
   Couldn’t tell you what that means for their stock short term.

   Reply