So far, the July 2008 acquisition of Countrywide Financial has brought to Bank of America’s table, $197 billion in lawsuits. The bank is in a mess and there appears no relief to the state that the beleaguered entity is in at present. There is one quick-fix solution though – a spin-off!
Back in 2006, Bank of America (BofA) was a different company – profitable and growing endlessly. On July 20, 2006, this growing feeling of conceitedness encouraged Kenneth Lewis (the-then CEO of BofA) to declare before a group of coffee-sipping, cookie-munching senior executives gathered in the auditorium of the bank’s headquarters in Charlotte, that everyone in the auditorium was now an employee of the “most profitable financial outfit in the world”. The verbal jubilation was an outcome of the company’s second quarter earnings (Q2, FY2006), which stood at $5.5 billion – the highest ever quarterly bottomline in the 102 year-old history of the financial outfit. In terms of market capitalisation too, then, BofA was just $4 billion away from taking over Citigroup as the world’s largest wealth manager. [It finally managed that on November 28, 2006, when its m-cap of $243.71 billion surpassed Citi’s $243.52 billion.] All was going well, until two years later, in July of 2008, BofA made a “relatively low-priced” acquisition worth $4.1 billion. That was to change its future, perhaps forever. It was the second-lowest amount spent by BofA in its endeavour to grow inorganically during the past decade – lowest being the $3.3 billion spent on acquiring The US Trust Company from the Charles Schwab Corporation on July 1, 2007 – an exercise which it had managed well till then. But in its effort to outrun and outspend competition, BofA hardly realised that this one deal was synonymous to a blindfolded banker running into a pit of “bad loans”. Countrywide Financial was that pit.
At $4.1 billion, the deal came across as a good bargain, given that the mortgage major had delivered a return of 23,000% to shareholders between 1982 and 2003 (more than what Washington Mutual, Walmart and Berkshire Hathaway managed in the same period). Moreover, the acquisition promised to consolidate BofA’s position as the leading mortgage originator in US. What BofA ignored was the fact that Countrywide had achieved all this by touring on the subprime mortgage bus.
In FY2008, BofA’s revenues stood at $124.13 billion, with net profits of $4.01 billion. Even as the subprime mortgage scandal unfolded, claiming victims in the third and fourth quarter of 2008, the bank’s operational structure withstood all punches. Revenues and profits rose to $120.95 billion and $6.27 billion respectively in FY2009. But behind the curtains, the bank’s financial DNA had changed fast and dangerously so.
In 2007, the contribution of the highly volatile package of home loan & insurance businesses to its topline was just 5.4%. This changed to 12.5% in 2008, 14% in 2009 and then (understandably fell) to 9.5% in 2010. During FY2009 and FY2010, as more foreclosures surfaced and customers defaulted on their home loans (coupled with troubles with credit card defaults, which contributed to 23.1% of its topline during the two years), BofA suffered losses amounting to $5.79 billion (losses arising out of the credit card, home loan & insurance businesses during the two years totalled $24.9 billion).
Till date, BofA has been paying the price of loans issued by Countrywide. In fact, just after BofA settled a $8.5 billion lawsuit filed by a consortium of 22 investors in June this year (related to bad mortgages), the American Insurance Group (AIG) sued BofA on August 10, 2011, for $10.5 billion, alleging that the bank and its subsidiaries issued defective mortgages to borrowers who were not in a position to repay and then repackaged them into securities worth $28 billion which were then sold to AIG.
BofA’s Q2 results for this fiscal don’t look encouraging either. The bank posted a net loss of $8.8 billion (its worst ever!). Speaking to B&E from Chicago, Jim Sinegal, Associate Director of Morningstar, says, “Thanks primarily to its $4 billion acquisition of Countrywide in 2008, BofA now possesses tens of billions of dollars in potential legal liabilities. Earnings must improve substantially in order for the bank to achieve escape velocity from the weight of billions of dollars in legacy mortgage-related liabilities threatening to reduce capital to unacceptable levels.” Under the purview of limited liability laws, stakeholders of a publicly-listed entity are not liable for its defaults. In this case, the shareholder is BofA. This implies that the bank can treat its bleeding bottomlines, if it is to pull the shutters on Countrywide. So, the question is – why hasn’t BofA taken bankruptcy protection on Countrywide yet? Because it cannot.
At $4.1 billion, the deal came across as a good bargain, given that the mortgage major had delivered a return of 23,000% to shareholders between 1982 and 2003 (more than what Washington Mutual, Walmart and Berkshire Hathaway managed in the same period). Moreover, the acquisition promised to consolidate BofA’s position as the leading mortgage originator in US. What BofA ignored was the fact that Countrywide had achieved all this by touring on the subprime mortgage bus.
In FY2008, BofA’s revenues stood at $124.13 billion, with net profits of $4.01 billion. Even as the subprime mortgage scandal unfolded, claiming victims in the third and fourth quarter of 2008, the bank’s operational structure withstood all punches. Revenues and profits rose to $120.95 billion and $6.27 billion respectively in FY2009. But behind the curtains, the bank’s financial DNA had changed fast and dangerously so.
In 2007, the contribution of the highly volatile package of home loan & insurance businesses to its topline was just 5.4%. This changed to 12.5% in 2008, 14% in 2009 and then (understandably fell) to 9.5% in 2010. During FY2009 and FY2010, as more foreclosures surfaced and customers defaulted on their home loans (coupled with troubles with credit card defaults, which contributed to 23.1% of its topline during the two years), BofA suffered losses amounting to $5.79 billion (losses arising out of the credit card, home loan & insurance businesses during the two years totalled $24.9 billion).
Till date, BofA has been paying the price of loans issued by Countrywide. In fact, just after BofA settled a $8.5 billion lawsuit filed by a consortium of 22 investors in June this year (related to bad mortgages), the American Insurance Group (AIG) sued BofA on August 10, 2011, for $10.5 billion, alleging that the bank and its subsidiaries issued defective mortgages to borrowers who were not in a position to repay and then repackaged them into securities worth $28 billion which were then sold to AIG.
BofA’s Q2 results for this fiscal don’t look encouraging either. The bank posted a net loss of $8.8 billion (its worst ever!). Speaking to B&E from Chicago, Jim Sinegal, Associate Director of Morningstar, says, “Thanks primarily to its $4 billion acquisition of Countrywide in 2008, BofA now possesses tens of billions of dollars in potential legal liabilities. Earnings must improve substantially in order for the bank to achieve escape velocity from the weight of billions of dollars in legacy mortgage-related liabilities threatening to reduce capital to unacceptable levels.” Under the purview of limited liability laws, stakeholders of a publicly-listed entity are not liable for its defaults. In this case, the shareholder is BofA. This implies that the bank can treat its bleeding bottomlines, if it is to pull the shutters on Countrywide. So, the question is – why hasn’t BofA taken bankruptcy protection on Countrywide yet? Because it cannot.
Source : IIPM Editorial, 2012.
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
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IIPM: Indian Institute of Planning and Management
An Initiative of IIPM, Malay Chaudhuri
and Arindam Chaudhuri (Renowned Management Guru and Economist).
For More IIPM Info, Visit below mentioned IIPM articles.
IIPM Best B School India
Management Guru Arindam Chaudhuri
Rajita Chaudhuri-The New Age Woman
IIPM's Management Consulting Arm-Planman Consulting
IIPM Prof. Arindam Chaudhuri on Internet Hooliganism
Arindam Chaudhuri: We need Hazare's leadership
Professor Arindam Chaudhuri - A Man For The Society....
IIPM: Indian Institute of Planning and Management
