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Long-term investors of Bank of America (NYSE: BAC ) are certainly a stoic bunch. Despite a multitude of setbacks over the past few years, there are plenty are still hanging in there, waiting for the miracle that will bring the bank back to its former glory. Meanwhile, they have their dreams: What if B of A was to drop off of everyone's litigation radar? What if its mortgage unit was to actually make a profit? What if -- gasp! -- they were to pay a half-decent dividend?
In other words, what if B of A hadn't bought Countrywide Financial, and then compounded the problem by acquiring Merrill Lynch?
A bank haunted by acquisitions past
Hindsight being what it is, there are surely no holdouts left who would argue that these two acquisitions have proved to be stellar business decisions. When Bank of America acquired Countrywide in 2008, however, the bank was looking to expand its mortgage-arm reach, and a 7.6% discount to buy the troubled lender must have looked like a true bargain. B of A was certainly aware of the lender's problems at the time, and must have known of the near-death experience of Lehman Brothers the prior year, because of its involvement with subprime loans.
But B of A and Countrywide had a prior relationship, and the bank had handed over $2 billion in aid to the subprime lender, for which it received an interest of 16%. For an additional $4 billion, Bank of America could have the whole ball of wax -- which added up to more than $400 billion in home loans, as well as servicing rights on mortgages valued at $1.5 trillion. Even folding in higher-than-average default rates must have made this look like an incredible deal.
Merrill Lynch: What was B of A thinking?
If Bank of America can be forgiven for being sucked into the Countrywide mess, it is harder to understand why, later that year, it would turn around and purchase a train wreck like Merrill Lynch.
The company had been on a mergers-and-acquisitions rampage for years, absorbing profitable institutions such as First Republic Bank (NYSE: FRC ) , but spending close to $3 billion on less stellar purchases as well, such as subprime lender First Franklin. Even as the terms of a merger were being discussed, losses were accruing at Merrill. Still, despite B of A's reluctance to pursue the deal, the bank let regulators talk them into it.
To its credit, Bank of America tried to stem the flow of red ink by unloading non-core assets soon after its purchase of Merrill. The decision to sell First Republic, inherited with the Merrill purchase, was probably another in a string of bad calls made by the bank, however.
Bank of America sold First Republic to a private equity group in 2010 for $1.86 billion, just a smidge above the $1.8 billion price Merrill had paid two years earlier. First Republic caters to wealthy customers, managing their billions of dollars and selling lucrative jumbo mortgages.
At the time of the B of A sale, the bank had nearly $20 billion in assets; today, it stands at $29 billion. Since its buyers took the bank public shortly after acquiring it from B of A, it has been an investor favorite, too: Its market cap has grown from the IPO value of $3.27 billion to $4.47 billion. Although the bank was independently run during its tenure with Merrill and then Bank of America, it seems to me that a growing concern like First Republic would have had a positive effect on B of A's balance sheet.
Acquisitions have cost Bank of America a small fortune
Both additions to the B of A family have cost the parent dearly. Countrywide may have come cheap, but experts estimate current losses resulting from the acquisition to be in the neighborhood of $42 billion. That number is bound to go up as new lawsuits come to light. Just this month, Washington Federal sued for losses it incurred through loans it purchased through Countrywide from 2004 to 2007, and the U.S. government has just sued the company on charges of mortgage fraud, expecting to levy more than $1 billion in fines and penalties.
As for Merrill Lynch, the original $50 billion price tag B of A paid was steep enough, and losses at the division of approximately $28 billion had accrued before the purchase documents were even signed. Late last year, B of A settled a case for $315 million in a securities fraud class action case, and it recently agreed to pay a record $2.43 billion to settle with shareholders that allege that the losses of 2008 were kept from them during the merger.
An ongoing problem
Analysts agree that Bank of America's recovery has been held back by these two acquisitions. Merrill Lynch, at least, has contributed to the bank's bottom line over the years, and its acquisition was bolstered by public money regulators threw in the kitty to assure that the deal was sealed. Countrywide, on the other hand, has been nothing but a big drain.
Doubtless, more lawsuits are on the way. The government is on a roll, with the U.S. Attorney filing lawsuits against Wells Fargo (NYSE: WFC ) for selling dicey mortgage-backed securities to the Federal Housing Administration, and a recent suit filed by the New York Attorney General against JPMorgan Chase (NYSE: JPM ) for securities-fraud violations committed by Bear Stearns. Those two banks managed to post a profit this past quarter, however -- unlike Bank of America.
What would Bank of America look like now if it hadn't bought Countrywide and Merrill? Exact numbers aren't available, but I can venture a guess: Bank of America would have bounced back to the current status of peers JPMorgan and Wells Fargo even if it had bought Merrill Lynch -- but not Countrywide -- and here's why.
Despite Merrill's lofty price and inauspicious start, the division has made money for B of A -- up to half of revenues for the past three years. Countrywide has cost the bank money pretty much non-stop, and despite B of A's increase in mortgage revenue this past quarter, that nasty loan portfolio engendered a loss of $877 million.
In addition, most of the loan income increase came from refinances, since B of A has backed off from the mortgage industry since the financial crisis. In my opinion, this means Bank of America won't duplicate the big profits we've seen from the likes of Wells Fargo, even when housing picks up. This is a severe limit on revenue, which I believe is mostly due to the Countrywide debacle, which has kept B of A's mortgage department in the red since 2008.
Recovery will take years
There's no doubt Bank of America will bounce back, but its mortgage cleanup will take several more years, which means more losses. An investment of $5 billion last year by Warren Buffett may have temporarily lifted investor spirits, but B of A needs a plan beyond cash infusions if it is to become strong again -- and finally become the bank its shareholders dream of, and deserve.
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