Bank of America, Wachovia Profits Slump on Mortgage Writedowns

Bank of America Corp. and Wachovia Corp., the second- and fourth-largest U.S. banks, said earnings plummeted after more than a combined $6.9 billion of market writedowns.

Bank of America's fourth-quarter profit dropped 95 percent to $268 million, while net income at Wachovia was almost wiped out, plunging 98 percent to $51 million. Bank of America declined 5.5 percent in early New York trading to $34 and Wachovia fell 4.4 percent to $29.46.

Kenneth Lewis, Bank of America's chief executive officer, and Kennedy Thompson, his counterpart at Wachovia, said in separate statements today that the companies were battered by the fixed-income markets. Lewis said he expects economic growth to be anemic at best in the first half.

Bank of America and Wachovia, both based in Charlotte, North Carolina, reported the lowest quarterly profits in at least six years during the country's worst housing slump in more than two decades. The world's biggest banks and brokerages have disclosed more than $120 billion of writedowns and credit losses since June, mostly caused by the collapse of the subprime mortgage market.

Bank of America earned 5 cents a share in the fourth quarter, excluding merger and restructuring costs and a gain from the sale of Marsico Capital Management LLC, falling short of the 21-cent average estimate from 21 analysts surveyed by Bloomberg. Wachovia's profit of 8 cents a share, excluding takeover-related costs, also missed analysts' estimates.

`Slowing Economy'

Our fourth-quarter results were severely impacted by ongoing dislocations in capital markets and the slowing economy, Lewis said in today's statement. He added that the company is cautiously optimistic about 2008.

Bank of America increased its bet on the faltering U.S. economy earlier this month by agreeing to acquire Countrywide Financial Corp., the largest U.S. mortgage lender, for about $4 billion in stock. Countrywide has dropped 36 percent in New York trading since the takeover was announced as investors speculate that Bank of America may seek better terms or abandon the deal.

Countrywide would give Bank of America a 25 percent share of U.S. mortgage originations, Lehman Brothers Holdings Inc. analyst Jason Goldberg wrote in a Jan. 11 report to clients. Almost two-thirds of Countrywide's loan originations in 2007 came from mortgage brokers and other third parties, a practice that Lewis has said Bank of America expects to curtail.

The corporate and investment bank lost $2.76 billion, compared with a profit of $1.4 billion a year earlier, and earnings at the consumer and small-business banking unit declined 28 percent to $1.87 billion. Lewis has scaled back investment banking by cutting 1,150 jobs since October and putting the hedge-fund brokerage unit up for sale.

First Drop Since 2001

Investment banking isn't Ken Lewis's core competency and he doesn't need it, says Bruce Foerster, a former Lehman Brothers managing director who's now president of the South Beach Capital Markets advisory firm in Miami.

Bank of America's total fourth-quarter revenue fell 31 percent to $12.7 billion, while non-interest costs rose 15 percent to $10.1 billion. Return on equity, a gauge of how effectively the company reinvests profit, declined to 11.1 percent for the year from 16.3 percent in 2006.

Full-year earnings dropped for the first time in Lewis's tenure since the 60-year-old CEO succeeded Hugh McColl Jr. in 2001, with net income sliding 29 percent to $15 billion.

Wachovia's fourth-quarter earnings were the lowest since 2001 after $1.7 billion of writedowns, including $1 billion for subprime mortgage-related holdings. The company's corporate and investment bank had a loss of $596 million after the costs.

Golden West

The continued turmoil in the capital markets and the dramatic change in the credit environment diminished our fourth- quarter results substantially, Thompson said in the statement.

Fourth-quarter revenue fell 17 percent to $7.2 billion. Return on equity was 0.28 percent, down from 13.1 percent a year earlier. The net interest margin, the difference between what Wachovia pays for deposits and what it charges on loans, narrowed to 2.88 percent from 2.92 percent on Sept. 30.

Wachovia has dropped almost 45 percent in New York trading since the company acquired Golden West Financial Corp. for $24.6 billion in October 2006 just before the housing market peaked. Since then, U.S. home sales slumped 21 percent to the lowest in 26 years.

They've got a tiger by the tail in Golden West and I don't think they know what to do, said Nancy Bush, an independent bank analyst in Aiken, South Carolina, who has a hold rating on Wachovia.

Countrywide On Clearance

Countrywide Financial may have found a white knight in Bank of America, but the mortgage lender was forced to put itself on the auction block for a steep discount.

On Friday, Bank of America confirmed that it will buy Countrywide Financial for $4.1 billion, delivering a much-needed lifeline to the embattled mortgage lender. But the deal, which values Countrywide's shares at $7.07 a share, well below Thursday's closing price of $7.76, simultaneously exposes the dire state of the nation's largest mortgage lender and the industry as a whole.

In early afternoon trading, shares of Countrywide plunged 16.3%, or $1.26, to $6.49, while Bank of America edged down 1.2%, or 47 cents, to $38.83. This deal comes together because no one wanted to see Countrywide fail; it is a win-win for everyone involved, but doesn't indicate that the mortgage problems are behind us, Stifel Nicolaus analyst Christopher Brendler told Forbes.com.

Under the deal, Countrywide shareholders will get 0.1822 of a Bank of America share for each share that they own.

The fact that Countrywide was willing to take a deal that valued it shares 8.3% below trading levels reveals just how desperate the firm was. It was certainly good news for Countrywide, Brendler said. Countrywide was going to have funding issues, liquidity had dried up for the sector, bankruptcy was a real risk.

This is not the first time Bank of America has stepped in to stabilize Countrywide. Back in August, Bank of America pumped $2 billion into Countrywide, buying up 111 million shares at $18 a share. According to Brendler, Bank of America was likely interested in buying Countrywide then, but Countrywide was hoping to go it alone. Since August, the credit and housing markets have worsened considerably, forcing many firms to take big write-downs or close their mortgage business alltogether. The rapid deterioration has pummeled Countrywide Financial, and, with Chapter 11 rumored to be at its heels, the firm likely had no choice but to accept a lowball deal.

This week, Countrywide reminded the markets that foreclosures were on the rise and said it funded just $23.5 billion in loans in December (roughly half the volume of a year ago).

Although Bank of America's stock may react negatively to the bailout news, the takeover of one of the most high-profile mortgage franchises at a bargain-basement price will be accretive in the long run. The acquisition, which will likely pass regulatory approval and close by the third quarter, will automatically turn Bank of America into the country's largest mortgage lender. As a major Wall Street player, with a huge balance sheet, Bank of America can easily absorb Countrywide's troubled portfolio. While the mortgage mess is far from over, Bank of America predicts that the takeover will be neutral to earnings in 2008 and positive by 2009.

Countrywide presents a rare opportunity for Bank of America to add what we believe is the best domestic mortgage platform at an attractive price and to affirm our position as the nation's premier lender to consumers, Bank of America Chief Executive Officer Ken Lewis said on Friday.

Of course, Countrywide is no sure bet. The company still has a dicey portfolio, with $80 billion in high-risk mortgage loans. Several months ago, many of these loans were not considered high risk, but the deterioration of the markets now makes them so, Stifel Nicolaus's Brendler said. Bank of America also acknowledged the possible risk associated with Countrywide in Friday's statement: We are aware of the issues within the housing and mortgage industries....The transaction reflects those challenges.

The Countrywide deal may also be a sign that the mortgage market will continue to worsen before it improves. This is more of a negative indicator; you have a company that has tried very hard to stabilize but has clearly failed to do so, and is selling for a very depressed price, Brendler remarked.

Others may follow. The next takeover target could be Washington Mutual, which ticked up 6.1%, or 87 cents, to $15.03 in premarket trading. However, Washington Mutual is a much larger pill to swallow, with $250 billion in mortgage loans on its books and a $12.3 billion market capitalization. Despite an attractive retail deposit business, there would be a limited pool of suitors. The top candidate would likely be JPMorgan Chase, Brendler observed.