Bank of America Dealt Devastating Blow by the Federal Reserve. Is It Finally Time for Shareholders to Jump Ship?

Less than a week after investors learned of a yet another massive multibillion-dollar legal settlement in the works at Bank of America (NYSE: BAC  ) , the nation's second largest bank by assets announced Monday morning it has suspended its much-touted dividend and share buyback increases effective immediately. If you're a shareholder of the Charlotte-based bank, you'd be excused for being disgusted.

There's no reason for me to delve into the details of the latest announcement, as my colleague Patrick Morris has already done an excellent job at that -- click here to see his explanation. The long and short of it is this: Bank of America incorrectly accounted for complicated financial assets acquired in its 2009 acquisition of Merrill Lynch. The error caused it to overestimate its regulatory capital ratios, which, in turn, is why the Federal Reserve demanded a suspension of its recently approved capital plans.

The news on Monday serves as a serious blow to the narrative that Bank of America has finally put its previous misdeeds in the rearview mirror -- one that I had ascribed to. According to my research, the bank has been on the hook in 47 major legal settlements since the financial crisis -- and at least four more are in the works. The cases run the gamut from submitting fraudulent documents in foreclosure proceedings, to racial and gender discrimination, to rearranging customer debit-card transactions in order to maximize overdraft fees, to originating toxic mortgages which were then sold to institutional investors, to fixing the results of ostensibly neutral credit card arbitration proceedings. And the list goes on.

Does the latest revelation rise to the same level as these? In and of itself, the answer seems to be "no." In the first case, while it seems like accounting for the value of financial instruments should be a relatively cut-and-dry exercise, the reality is that there's as much art to the process as there is science. On top of this, as Patrick discussed in the article cited above, Bank of America should be given credit for being forthcoming with the discovery to its regulators -- though, it's certainly a revealing commentary on corporate America and the financial industry in particular that one feels the need to commend honesty.

At the same time, news that Bank of America has suspended its long-awaited dividend increase must certainly leave analysts and investors wondering when enough is enough. In the field of law, evidence of past misdeeds generally isn't admissible to prove subsequent crimes. An important exception is if the volume and nature of past misdeeds rise to the level of habit, in which case the previous indiscretions can be used to prove that a person – or, in this case, a company -- merely acted in conformity with them at a later date. My point is that perhaps the mounting tally of legal settlements and revelations of highly questionable business practices aren't exceptions to Bank of America's standard operating procedure. Instead, perhaps they are its standard practice.

Take this excerpt from Warren Buffett's 1985 letter to shareholders:

In any business, insurance or otherwise, 'except for' should be excised from the lexicon. If you are going to play the game, you must count the runs scored against you in all nine innings. Any manager who consistently says 'except for' and then reports on the lessons he has learned from his mistakes may be missing the only important lesson -- namely, that the real mistake is not the act, but the actor.

Aside from the irony that Buffett's Berkshire Hathaway (NYSE: BRK-A  ) is Bank of America's biggest shareholder, I think shareholders would be smart to take his comments into consideration.

It's worth observing, for instance, that the bank has continued to behave in questionable ways even after falling squarely under the gaze of regulators and consumers. To name only one example, at the end of last year, Bloomberg News revealed a secret office set up by the bank and misleadingly named the "Office of the CEO and President." Its purpose was to reassure aggrieved mortgage customers that complaints were being taken seriously by people at the pinnacle of the banking behemoth. But the reality couldn't have been further from the truth -- both figuratively and geographically -- as the calls were actually routed to independent contractors based in Broomfield, CO.

The question for long-hopeful shareholders of Bank of America is this: Is it finally time to abandon ship? Although it's tempting to answer this in the affirmative, I can't help but admit that I'm still optimistic about the bank as a long-term investment. Granted, it has major problems. And granted, many of these problems are revealing not just about its past practices but about its current ones as well. Yet, over the long course of time, I, perhaps naively, believe that the bank will someday move beyond these issues once and for all. Unfortunately, as we learned yet again on Monday, it will just take even longer than previously thought.

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Read/Post Comments (15) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 28, 2014, at 3:34 PM, pondee619 wrote:

    Your paragraph that begins;

    "The question for long-hopeful shareholders of Bank of America is this: Is it finally time to abandon ship?"

    and ends with;

    "I, perhaps naively, believe that the bank will someday move beyond these issues once and for all. Unfortunately, as we learned yet again on Monday, it will just take even longer than previously thought.";

    more than mere hope?

    I note, "John Maxfield has no position in any stocks mentioned." including BoA. "I can't help but admit that I'm still optimistic about the bank as a long-term investment" but I aint owing any?

  • Report this Comment On April 28, 2014, at 5:32 PM, Dummy39 wrote:

    How can you guys not apologize for recommending Lnkd stock. Your spokesman said he was buying 117000 worth of stock. And that was 3 months ago...Did he ever buy it?. Or is he a damn liar.he recommended it about 100 points ago. LETS SEE YOU ANSWER THAT! Come on have some balls At least admi You made a mistake

  • Report this Comment On April 28, 2014, at 5:33 PM, Dummy39 wrote:

    You guys are THE WORST,,

  • Report this Comment On April 28, 2014, at 6:50 PM, GETRICHSLOW2 wrote:

    Sounds like Buffet might be issuing another Mea Culpa in next years letter.

  • Report this Comment On April 28, 2014, at 7:09 PM, JohnMaxfield37 wrote:

    pondee619,

    I explain why I sold my BAC earlier this month in the following article (spoiler alert: my wife and I bought a house and needed the cash for a down payment):

    http://www.fool.com/investing/general/2014/04/07/why-im-sell...

    John

  • Report this Comment On April 28, 2014, at 7:33 PM, djtetsu wrote:

    You seem very negative on BAC, and that's understandable, but the number or articles you write on your view seem to indicate you have an emotional attachment (to seeing the stock go down). Now seeing that you've sold your shares it make sense.

  • Report this Comment On April 28, 2014, at 7:45 PM, JohnMaxfield37 wrote:

    djtetsu,

    From the last paragraph of this article:

    "I can't help but admit that I'm still optimistic about [Bank of America] as a long-term investment. Granted, it has major problems. And granted, many of these problems are revealing not just about its past practices but about its current ones as well. Yet, over the long course of time, I, perhaps naively, believe that the bank will someday move beyond these issues once and for all."

    John

  • Report this Comment On April 28, 2014, at 8:38 PM, tem85749 wrote:

    B/A is dealing with an inherent culture issue. It won't get better until there is integrity within the culture, top to bottom. It takes a very long time to change culture and simply writing another settlement check won't fix the problem. It has to start at the top. I'm selling, when the market opens.

  • Report this Comment On April 29, 2014, at 12:22 AM, aacole wrote:

    Stock is a "buy": Why?

    1) corruption doesn't matter

    2) Too big to fail....

    3) corollary to (2) it"ll come back

    4) I bought when the stock was higher

  • Report this Comment On April 29, 2014, at 1:15 AM, zspeed74xr wrote:

    @Dummy39 The video you mention is atleast a year old, not 3 months. Becareful you don't fall victim to old information. That said, they obviously in hindsight should have moved it to hold when it reached 250 like they did with TSLA.

    Now back to the current topic please.

  • Report this Comment On April 29, 2014, at 8:28 AM, pondee619 wrote:

    John:

    That does not answer the question. The paragraph referenced, mere hope or something more substancial? Side stepping the question only leads to suspicion.

    BTW, fortuitous timing on your sale, but my question still goes unanswered. Is your naive belief based on something real?

    Congrats on the purchase. May you and your family enjoy many happy years there.

  • Report this Comment On April 29, 2014, at 9:27 AM, ScoopHoop wrote:

    I've largely stayed away from banks because you don't really know what is in their balance sheets, they have thin margins and depend on people to pay back these loans. Non-accrual loans can be hidden for awhile, but not forever, eventually they come to light. Most people pay back their loans, but some people don't, and they don't care. Screw the banks is their attitude. You pointed out that Bank of America "has been on the hook in 47 major legal settlements since the financial crisis -- and at least four more are in the works." Now we know the company miscalculated its financial assets acquired in its 2009 acquisition of Merrill Lynch. Who is doing the accounting here? This bank is not to be trusted. As one portfolio manager told me, if you can't trust the company, sell it.

  • Report this Comment On April 29, 2014, at 10:37 AM, JohnMaxfield37 wrote:

    pondee619:

    My optimism is based on a number of things.

    First, BAC has and continues to make progress in its Legacy Assets & Servicing division. This is where it holds all of its "non-core" assets that are running off. It's also the unit responsible for servicing delinquent mortgages dating back to before the crisis. Once those portfolios are gone, BAC should earn a consistent and, at least compared to now, considerable profit on a regular basis, as LAS is the principal drag on BAC's earnings.

    Here's an article that touches on this:

    http://www.fool.com/investing/general/2014/04/17/3-critical-...

    Second, as is the case in this period of the cycle, the quality of assets that BAC is putting on its books now, at least according to its financial statements, are very good. Over the next decade or so, this should yield low loan losses.

    Here's a piece I wrote a while back on the centrality of high quality asset portfolios:

    http://www.fool.com/investing/general/2013/09/11/the-most-im...

    Third, interest rates are still historically low. Once the Fed Funds Rate increases, which it's bound to do at some point, BAC and others will earn more from their assets (most big backs are "asset sensitive," meaning their net interest income is tied to the short end of the curve and not the long end).

    I discuss asset sensitivity in relation to KeyCorp here:

    http://www.fool.com/investing/general/2013/12/03/1-thing-inv...

    And fourth, it's still (and particularly after yesterday's news) trading for a healthy discount to book value. Now, let me be clear, it may never be entitled to the same premium as WFC. However, once the three things mentioned above come together, I can't help but believe that its valuation will improve as well.

    The one outlier are elevated compliance costs. BAC, as you probably know, has a serious problem with expenses. Off the top of my head, its efficiency ratio is in the high 70% range. Now, BAC is trying to bring this down, but the increased compliance costs will, to a certain extent, work against these efforts.

    John

  • Report this Comment On April 29, 2014, at 6:21 PM, jack214 wrote:

    I got out of bac 2.5 years ago with a big loss and some other big banks. I have not bought any banks since and have no intensions of buying the house of crooks.

  • Report this Comment On April 30, 2014, at 11:43 AM, pondee619 wrote:

    John:

    I thought I had thanked you for your prompt and complete reply. It apparently did not get published. Therefore,

    Thank you.

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