There should be a health warning on major banks buying other large banks. The wreckage of such deals litters recent banking history. RBS and ABN Ambro springs to mind, as does the purchase of the hugely toxic HBOS by Lloyds at the UK government’s behest. Then, of course, there is the $4 billion purchase of Countrywide Financial by Bank of America in 2008.
If ever there was a deal that any sane bank board should have walked away from, this was it. By 2008 you had to be blind not to see the imminent bust in the US housing market, for the said bust was gathering visible momentum. Buying Countrywide, which specialised in sharp mortgage practices and writing as much sub prime as it could get, was a wonderful way of gaining mammoth exposure to the coming bust.
Jack Barnes, Global Macro Trends specialist at Money Morning, has a great line on his reaction to the deal: “When I heard about Bank of America’s takeover of Countrywide Financial, I was shocked to the point of giggling,” he recalls. Some decisions are so bad they just take you that way.
The poison in Countrywide has taken time to work, but it is now doing a huge amount of damage to Bank of America, which would have had more than enough on its plate had it never gone anywhere near Countrywide. According to media reports (see, for example, The New York Times) Countrywide has already cost Bank of America in excess of $30 billion and Bank of America’s CEO, Brian Moynihan, has chosen to sell an equivalent amount of BoA assets in an attempt to right the ship. Had someone told Moynihan’s predecessor, Kenneth Lewis, that the real price tag for Countrywide would turn out to be more than $34 billion, perhaps very significantly more, one imagines the deal would not have been done even had Lewis been gifted this particular poisoned chalice. Much the same could be said for Lloyds purchase of HBOS.
There has been a good deal of debate recently about the state of health of BoA, and whether it is in fact bust, or at least borderline, and whether, prior to a $5 billion investment by legendary financier Warren Buffett, the bank’s shares were taking a pounding. They had shed some 30% of their value through August. The price then surged up some 9% after Buffett’s deal, giving Buffett an immediate profit if he had wished to take it. He didn’t because he likes investing to hold, and anyway, even at the improved price, BoA shares are way off where they were in October 2007, giving plenty of room for Buffett to make a huge profit if BoA manages to shrug off its current woes. Under the deal, Buffett’s Berkshire Hathaway gets $300 million a year in interest payments and the right to buy 700 million BoA shares at $7.14 per share.
BoA has been vigorously denying that there is any problem with its capitalisation and it has been insisting, with equal vigour, that it is solvent, which is to say that its assets exceed its liabilities. However, the doubts persist. Barns points out that BoA is now one of the largest owners of private housing in the US thanks to all the foreclosed property on its books, and the value of that property is now an open question, never mind the delinquent and soon-to-be-delinquent mortgages it holds. So whether BoA is adequately capitalised or not comes down in the end to various acts of faith over hard-to-prove asset valuations. Barnes also notes that BoA’s rapid growth in the pre-crash era came through M&A deals, not all of which were horrendous, but those deals have left it with a slew of operations that are in difficulties in the current low-to-no growth economy.
On top of this the law suits are piling up. AIG recently filed a $10 billion lawsuit in an attempt to recoup some of its losses on mortgage backed securities and a $8.5 billion proposed settlement by BoA to settle a package of claims had, at the time of writing, been challenged by investors. Plus, there is the small fact that the attorneys in all 50 US states, as well as the federal government, are looking for a big payout from US mortgage servicers, said to be in the region of $30 billion. BoA is America’s biggest mortgage servicer and as such could end up paying out billions on this front too.
Of course, BoA is not a small beast. It holds some $300 billion worth of mortgages and home equity loans and it claims to have in excess of $1 trillion worth of deposits. And if it did blunder in buying Countrywide, it can point to more than a little success from its acquisition of Merrill Lynch, which has put it on the map as far as investment banking and capital markets are concerned.
Perhaps the clearest thing to emerge from all the furore over BoA is that it is extremely difficult for any outsider to get a clear view of the actual state of health of any major bank – until the wheels really come off. One can only hope that the boards of major banks are not flying equally blind – and what, pray, are their auditors making of all this? PWC, BoA’s auditors, have a bit of a challenge on their hands…
Further reading on the financial sector and corporate governance:
- Reducing corruption and the kleptomania of autocrats the EITI way by Ian Fraser (blog)
- Global Ambitions—China’s Big Banks by Sir John Stuttard
- Why the “Credit Crunch” May Be Good for Corporate Governance by Terry Carroll
Tags: ABN Ambro , AIG , Bank of America , Berkshire Hathaway , BoA , Brian Moynihan , corporate governance , Countrywide Financial , financial sector , Global Macro Trends , HBOS , Jack Barnes , Kenneth Lewis , Lloyds , Mergers and Acquisitions , Merrill Lynch , Money Morning , mortgage backed securities , Royal Bank of Scotland (RBS) , sub prime fiasco , The New York Times , Warren Buffett