Sometimes a company needs a mulligan. Decisions can have unintended consequences, and a second chance to go back and have a do-over knowing what we know now could make all the difference. For Bank of America, the mulligan moment came on July 1, 2008, when it announced that it had purchased Countrywide Financial, the beleaguered mortgage company at the heart of the subprime mortgage crisis. The $4.1 billion purchase didn't go as planned, and now Bank of America is facing at least $60 billion in mortgage-related claims. Bank of America doesn't just need a mulligan, it needs a time machine. Call Doc Brown and tell him to warm up the DeLorean.
TUTORIAL: Banking: Introduction
On the face of things, Bank of America is clearly in trouble. It has closed bank branches and has announced it is firing 10% of its staff, 30,000 employees, leading some to fear that other banks will take over its mantle as the "bank found everywhere." It is being targeted by firms who invested in its mortgages, and has drawn the ire of federal and state governments. Share prices have plummeted 75% from the purchase date to July 2011.
Is It That Bad?
Everything is not as bad as it seems. A string of acquisitions has left the company operating overlapping data centers, so consolidation and layoffs were inevitable. The other primary issue is from claims lodged against the company. By far the largest chunk of claims - upwards of $60 billion - stems from Countrywide. Even American International Group (AIG), a company synonymous with the mortgage meltdown, is suing Bank of America for mortgages issued by Countrywide. As ominous as this may sound, the continued litigation is slowly whittling away whatever assets Countrywide has left to the point in which the company could be sent off into bankruptcy purgatory. Can Bank of America do this? It depends on whose side you are on. (For related reading, see Analyzing An Acquisition Announcement.)
Bank of America's out might be the Dodd-Frank Act, a piece of legislation that has prompted howls of anguish from all sides since being signed into law in 2010. One provision of the Act, Title II, creates an Orderly Liquidation Panel charged with determining if a company on the brink of collapse can be placed into receivership under the Federal Deposit Insurance Corporation (FDIC). The FDIC would then proceed with liquidating the company. If Countrywide's assets continue to evaporate under legal pressure, Bank of America could shift the company into bankruptcy proceedings.
The Way Out
At the heart of the matter is whether Bank of America is really responsible for Countrywide's liabilities. If Bank of America acquired Countrywide and assumed its liabilities, it would be on the hook for claims from companies that had previously conducted business with Countrywide. However, if Bank of America kept Countrywide as a separate legal entity then Bank of America may have an out. In the case of the Countrywide acquisition, Bank of America bought out its stock, just as an average investor may buy shares in Exxon or Apple. While it does control Countrywide as a business by controlling Countrywide's stock, laws protecting investors from debts incurred by the companies they invest in could apply to corporations investing in other companies as well. In this sense, Bank of America is no different than a very large, very rich Joe Sixpack.
Done deal, right? Not quite. This would have been Bank of America's out if it had kept the operations of Countrywide separate from its own operations, but this is not entirely the case. Bank of America entered into a series of fairly complex transactions in which it moved around Countrywide's debts and "paid" Countrywide by issuing it notes. Claimants are saying that this is proof that Bank of America should be on the hook because it was actively transferring Countrywide's assets around.
If Bank of America valued Countrywide's assets in a legitimate fashion, i.e. paid a reasonable sum for them, then this legitimizes the claim that it should not be on the hook for Countrywide's liabilities. If this holds up then the billions of dollars in claims against Bank of America and Countrywide could evaporate quickly. Claimants would scramble for whatever assets Countrywide is left with, and the FDIC would help guide the beleaguered mortgage giant to oblivion. This will take time, and by no means will the proceedings end quickly or without rancor.
TUTORIAL: Banking: Safeguarding Your Accounts
The Road Ahead
If Bank of America manages to navigate its way out of this mess investors may breathe a sigh of relief, but they should not let up on Brian Moynihan, Bank of America's CEO. Though the Countrywide purchase is widely panned, the company's acquisition of Merrill Lynch has also been fraught with miscues and missteps. Bank of America has struggled to effectively integrate the highly profitable wealth management services offered by Merrill into its retail banking services. It's possible that the company cast its net too wide and has become a leviathan without clear direction, as shareholders clamoring for a Merrill Lynch spinoff have been saying. The company may well keep Merrill around because it creates a one-stop-shop for consumers, and in a similar vein to Standard Oil, allows Bank of America to have its hands in more profitable pots. Without the billions of dollars in settlements and the constant string of lawsuits brought on by Countrywide, Bank of America may emerge as a very profitable bank. (For related reading, see Parents And Spinoffs: When To Buy And When To Sell.)