Is BofA Finally Quieting the Ghosts of Countrywide Financial?
In 2007, as the various storm fronts of the late-2000s financial crisis were beginning to collide and America’s major financial institutions were not yet flirting with disaster, Bank of America (NYSE:BAC) announced a $2 billion investment in Countrywide Financial Corporation, then the largest mortgage lender in the United States. The investment was made in the form of a massive non-voting security that would yield 7.25 percent per year and could be converted into common stock at $18 per share.
Bank of America’s then-Chairman and CEO Kenneth Lewis commented in a press release at the time that, “We believe that in the current turmoil the stock market has been underestimating the value in Countrywide’s operations and assets. This investment reflects our confidence in their business and recognizes the importance of the company in providing home financing across the country. We hope this investment will be a step toward a return to more normal liquidity in the mortgage markets. Countrywide has a strong mortgage origination business and it services the mortgages of one in seven American households.”
Just a few months later, in January, Bank of America announced that it would buy the entire corporation for about $4 billion. By March of that year, reports surfaced that the FBI was investigating Countrywide over allegations of fraud relating its its sale of mortgages.
At the time that the Countrywide purchases were announced in early 2008, Lewis commented that, “We are aware of the issues within the housing and mortgage industries.” But the potential for profit — Lewis noted that the purchase was made at an “attractive price” — was tremendous, and outweighed the perceived risks. Countrywide recorded $408 billion in mortgage originations in 2007 and had a servicing portfolio of 9 million loans worth about $1.5 trillion.
However, in 2007 the firm also reported a net loss of $703,538, or $2.03 per share, down from earnings of nearly $2.7 million in 2006 and $2.5 million in 2005. Its mortgage banking segment lost the lion’s share of the money with a loss of $1.5 million, a sum partially offset by positive earnings in its insurance segment.
With a certain prescience, under the terms of agreement for the deal the firms agreed not to pursue the origination of subprime loans, and added that, “Both companies share the goal of keeping distressed mortgage borrowers in their homes when possible. Both Bank of America and Countrywide continue to work with public officials and community groups to explore new initiatives to help homebuyers and communities affected by the subprime issue.”
However, the happy talk turned out to be a little over-optimistic. As recently as June, Bank of America was accused of deliberately denying eligible people for loan modifications, as well as lying to them about the status of their mortgage payments. Former bank employees allege that the firm incentivized employees to push people toward foreclosures through cash bonuses.
Since 2012, 18,000 home shave filed complaints to the Consumer Financial Protection Bureau about Bank of America alone. But these ongoing allegations are just echoes of the real fallout from Bank of America’s acquisition of Countrywide. In 2011, the bank announced that it was settling claims related to its exposure to residential mortgage-backed securities to the tune of $8.5 billion.
“This is another important step we are taking in the interest of our shareholders to minimize the impact of future economic uncertainty and put legacy issues behind us,” said CEO Brian Moynihan with the settlement announcement in 2011. Moynihan had taken over as chief executive in 2010. “We will continue to act aggressively, and in the best interest of our shareholders, to clean up the mortgage issues largely stemming from our purchase of Countrywide.”
These issues have found a home in Bank of America’s dense financial statements as Legacy Asset Servicing costs. In the second quarter of 2013, those costs were $2.3 billion. According to a research note seen by The Street, KBW analyst Christopher Mutascio expects these costs to reach a more normal level of about $500 million per quarter by the end of 2015. All told, that amounts to a cost reduction of $7.2 billion per year for the bank, which in many ways is a boon for its shareholders.
Bank of America has already outperformed its peers on the stock chart over the past 52-week period and is trading at a relatively high price-to-earnings that most other banks. In order to justify this P/E now, it will have to increase earnings later, which tremendous cost cutting can go a long way toward doing.
As it stands, Bank of America is trading at a forward P/E of 10.48. This compares to 10.29 at Wells Fargo (NYSE:WFC), 8.9 at Citigroup (NYSE:C), and 8.38 at JPMorgan (NYSE:JPM). Wells Fargo recently revealed that it would cut 29,000 jobs in its mortgage sector, according to people familiar with the matter, and that number could grow as fewer people choose to refinance due to high interest rates. That number accounts for about 20 percent of Wells Fargo’s mortgage loan officers.