We have downgraded our long-term recommendation on Bank of America Corp. (BAC) to Underperform on expected damages from the recent mortgage lawsuit filed against it by the U.S. Government. Its decision to settle legacy Countrywide mortgage repurchase and servicing claims had a severe impact on its second quarter 2011 results.
The company reported a second quarter loss of 90 cents per share, a penny narrower than the Zacks Consensus Estimate. But the figure compared favorably with the earnings of 27 cents in the prior-year quarter.
Excluding certain mortgage-related and other nonrecurring items, the company earned 33 cents per share during the quarter.
The core results were aided by a lower provision for credit losses. However, a weaker top line and higher non-interest expenses were the downsides.
The lawsuit filed by the U.S. Federal Housing Finance Agency (FHFA) on September 2, 2011 for reneging on commitments on the quality of mortgage securities sold to Fannie Mae and Freddie Mac is expected to severely impact Bank of America’s financials in the upcoming quarters.
Along with Countrywide and Merrill Lynch, Bank of America was sued for selling mortgage-backed securities worth $57.5 billion. At a crucial moment in a volatile world economy, compensation of billions would make it difficult for Bank of America to gain ground any time soon.
With Bank of America’s plan to boost dividend in the second half of 2011 being turned down by the Federal Reserve in March following the release of the second round stress test results, investors’ confidence in the stock has dampened.
Though the Fed has given the company another chance to submit a revised capital plan for its consideration, we do not expect Bank of America to achieve a stable financial state any time soon. Consequently, regulators will continue with their cautious approach.
We are also concerned about Bank of America’s elevated cost structure. Non-interest expenses rose significantly during the last four quarters. As the company is in the process of addressing legacy issues and continues to invest in its franchise, expenses are expected to remain high through 2011.
On the flip side, management remains focused on managing asset levels efficiently. The company has relentlessly tried to realign its balance sheet in accordance with the regulatory changes post meltdown to remain afloat. In fact, Bank of America remains committed to shedding its non-core assets, even after repaying the bailout money it had taken as part of its participation in the Troubled Asset Relief Program.
The primary reason behind this is to strengthen its capital position in order to reinstate the dividend hike, meet new international capital standards, focus on corporate borrowers and U.S. retail clients as well as fortify its investment banking operations.
Bank of America launched a company-wide efficiency initiative with the goal to improve earnings by lowering expenses, increasing revenue, enhancing risk control and making changes to allow better execution and serve customers, while returning more value to shareholders.
The company is mulling over retrenching 40,000 workers under the first phase of a proposed restructuring program to recover its financial position, the Wall Street Journal reported on Friday following communication with people familiar with the plans. The looming layoff scenario does not come as a surprise from a company fraught with a $1 trillion problem-loan portfolio.
Last month, BofA had announced plans to axe 3,500 workers this quarter. Thousands of additional layoffs were expected in the upcoming quarters, but the expected number of about 10,000 was substantially lower than the figure now feared.
The job cut initiatives explain the company’s attempt to improve profitability amid revenue headwinds arising out of a weak economy and stricter capital requirements by regulators. The company expects these expense reduction initiatives to benefit its financial performance in the second half of 2012.
Moreover, on September 6, 2011, BofA announced an immediate reshuffling of its top management, including the exit of two executives. The reorganization arranges the company’s operating units according to its key customer groups –– individuals, companies and institutional investors.
The departing executives are Sallie Krawcheck, head of global wealth and investment management, and Joe Price, president of the consumer bank. Former Citigroup (C) chief finance officer, Krawcheck was hired in late 2009. Joe Price, who was the chief financial officer under Lewis and joined BofA in 2010.
The management reshuffling is part of Bank of America’s cost-cutting program called Project New BAC, which it started in April 2011. The latest actions are part of the first phase of New BAC. The bank intends to implement more changes with the second phase beginning October and running through March 2012.
The whole intention behind this streamlining move is to remove a layer of operations management, aligning leaders with the company’s customer groups and simplifying the role and structure of the management team. According to Moynihan, de-layering and simplifying at the scale in which the company operates requires tricky decisions.
The company is significantly optimistic about the success of its management reshuffling. We, however, don’t think BofA will be able to overcome all its concerns with the management reshuffling at least in the near to medium term.
Currently, BofA retains a Zacks #3 Rank, which translates into a short-term Hold rating.
Zacks Investment Research
