On Tuesday, Bank of America (NYSE:BAC) gave us a glimpse into how well it has weathered the subprime storm. "Not well" would be an understatement. "Terribly" is a bit weak, too.

The Charlotte-based bank announced that fourth-quarter profits dropped 95%. Yes, 95%! The bank was hit by more than $7 billion in write-downs due to the deteriorating credit markets and massive trading losses. This comes on the heels of the bank's announcement to buy long suffering Countrywide Financial (NYSE:CFC), and a $6 billion preferred stock sale.



When The I-Banking Gets Tough, Just Get Rid of It
Bank of America's Q4 net income plunged to $268 million (5 cents per share) from $5.26 billion ($1.16 per share) one year earlier. In a press release covering the earnings numbers, CEO Kenneth Lewis said that the results were hurt by ongoing dislocations in capital markets and the slowing economy. He said that, even given the environment in the financial markets, "we certainly are not pleased with our performance."

Results included $5.44 billion of trading losses, down from profits of $460 million a year ago. This stemmed from $5.28 billion write-down related to collateralized debt obligations. These are really pitiful results, and I was a little surprised at how bad the numbers turned out. This poor performance has led the bank to announce a $6 billion preferred stock sale and given rise to the expectation of more job cuts. The bank has announced 3,650 job cuts since October, but this means that there will likely be many more. There is speculation that the bank has decided to largely exit the investment banking business and focus on what it does best, being a leading consumer bank.

Take Advantage of the Spread
I do not think the shifting of focus at Bank of America is a bad thing. Consumer banks generally get higher valuation multiples in the market, and Bank of America's pick-up of Countrywide also shows that it still has room to make big purchases and expand in the consumer arena. I think this was a smart purchase, and I think the deal has little downside with the price being paid. The deal was announced that stockholder's of Countrywide would receive 0.1822 shares of BAC for each one of their CFC shares. Assuming this goes through, it is a good value for Bank of America, and will help the bank save some face by expanding its consumer services, balancing out its shrinking I-Bank operations.

But it seems that the market is not pricing any of this in. Bank of America shares closed at $39.90 yesterday and Countrywide closed at $6.11. So, as of yesterday's close, 0.1822 shares of Bank of America was worth $7.27, or a 19% premium to Countrywide's share price. The deal closes in the third quarter, so there is potential for a nice profit with little risk. I wouldn't just buy CFC right now because considerable pressure could likely weigh down Bank of America shares more. But, if you have a margin account, you can short 1 share of Bank of America for every 5 shares of CFC you buy and take advantage of the spread. (For added insight, check out When To Short A Stock.)

The Bottom Line
Bank Of America has reported pitiful results with a 95% drop in net income for its fourth quarter. The company will most likely exit its investment banking business, which will allow it to focus on its stronghold consumer bank. I think the Countrywide deal is attractive, and while I would not buy shares of Countrywide flat out, there are ways to take advantage of the mispricing in the shares.



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Tickers in this Article: BAC, CFC

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