Call me crazy, but it appears that Bank of America (NYSE: BAC ) may have finally turned the corner. While its third-quarter earnings were nothing to write home about, the substance of its prepared remarks and the content of its earnings call mark a dramatic change in tone, from one focused exclusively on stemming losses to one directed toward growth and profitability.
Is this an inflection point?
The issue with B of A has never been about whether it can generate revenue. Make no mistake about it -- the nation's second largest bank by assets can do plenty of that. As the largest deposit holder in the world's biggest economy, controlling more than $1.1 trillion of the nation's liquid wealth, it makes more than $40 billion every year in net interest income alone. Not to mention the fact that it's now hitched to the infamous thundering herd of Merrill Lynch's 15,000-plus financial advisors and $2.2 trillion in client assets.
Instead, the issue has always been about how much it will lose as a result of past transgressions. In the midst of the financial crisis, the bank's then-CEO, Ken Lewis, made the now-fateful decision to purchase Countrywide Financial, the largest subprime-mortgage originator in the country at the time. Although it must have seemed like a prudent move then, it has since cost B of A more than $100 billion in subprime-mortgage charge-offs and exposed it to billions of dollars in liability for the souring mortgage-backed securities that house the toxic loans.
To borrow a phrase from Donald Rumsfeld, the concern that continues to plague B of A is the extent of the "known unknowns." In other words, we know it's on the hook for tens of billions of dollars in repurchase claims from public and private investors in its mortgage-backed securities, but we just don't know how many tens of billions of dollars.
In an article I wrote at the beginning of last month, I noted that between 2004 and 2008, B of A sold $1.1 trillion in mortgages and related securities to public investors such as Fannie Mae and Freddie Mac. A full $132 billion of those mortgages are now either in default or severely delinquent -- i.e., more than 180 days past due. After factoring in a number of additional variables, I concluded that B of A's liability from the associated repurchase claims could be anywhere between $4.7 billion and $40.9 billion.
And remember, this range relates only to public investors. B of A itself told us last quarter that it could face an additional $5 billion in losses above and beyond its reserves from private-label repurchase claims. Taken together, in turn, the potential liabilities were so astronomically large that it could have taken the troubled lender upwards of a decade to dig itself out -- that is, if federal regulators even gave it the opportunity to do so.
What about that inflection point?
To tie everything together, for the first time since the potentially fatal repurchase issue reared its ugly head, we now have an official estimate of the full extent of B of A's liability. On its second-quarter conference call, B of A's top executives dodged the answer to this question on multiple occasions, saying only that they expect repurchase claims to increase going forward. In the third-quarter conference call earlier this week, however, the bank's chief financial officer, Bruce Thompson, came right out with a precise answer:
"We currently estimate that the range of possible loss for both the GSEs [government-sponsored entities] and the non-GSEs for rep and warrant exposures could be up to $6 billion over our accruals at Sept. 30 and compared to the up to $5 billion over accruals at June 30, which, once again, were only for non-GSE reps and warrant exposures. The increase in the range of possible loss from our June 30 period is the net impact of, among other changes, updated assumptions and the inclusion of GSE rep and warrant exposure, as well as other developments."
So there it is: $6 billion above and beyond stated reserves. An extremely manageable figure.
What this means
While this all may sound like financial gobbledygook, it's huge news. These repurchase claims are B of A's last big hurdle before embarking on a path of sustainable profitability. Sure, it still has a lot of bad loans on its books, but so do all the other banks. Even Wells Fargo (NYSE: WFC ) and JPMorgan Chase (NYSE: JPM ) , the industry's golden children, have this problem -- to say nothing of Citigroup (NYSE: C ) , which just lost its CEO Vikram Pandit to a rage of sophomoric egotism. But B of A can absorb its losses from bad loans while still amassing capital to one day return to shareholders. And let it be known that you heard it here first: That day may be sooner than we all imagined.
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