On the afternoon of Aug. 23, Gary G. Lynch, the global chief of legal, compliance, and regulatory relations for Bank of America (BAC), was attending a meeting in Washington when the floor heaved. Although Lynch, a lanky 61-year-old attorney with swept-back white hair, had never experienced an earthquake, he possessed the good sense to get beneath a sturdy conference table, along with several other people. “If the ceiling came down,” he recalls, “I thought we were dead.”
The ceiling held, despite the magnitude 5.8 quake rippling from its epicenter in Virginia. Minutes later, Lynch pulled out his BlackBerry and discovered another startling development: a rumor rattling Wall Street that Bank of America might get swept into an involuntary, government-orchestrated rescue by its smaller rival JPMorgan Chase (JPM). “This is really getting nuts,” he thought.
Lynch, who as the head of enforcement at the Securities and Exchange Commission in the late 1980s brought Ivan Boesky and Michael Milken to heel, knew he’d come under heavy fire when he parachuted into BofA this July. His assignment: Defend against a seemingly endless barrage of multibillion-dollar lawsuits and government investigations concerning defective mortgage-backed bonds manufactured at the height of the real estate bubble. No sooner did one liability bomb explode than it was followed by another. Now Lynch was doing duck-and-cover for real, while the bank’s share price was pounded to within a whisker of $6, down more than 50 percent since Jan. 1. The wild speculation about a forced merger combined ominously with financial analyst chatter that the mortgage onslaught would drain BofA’s capital, requiring it to sell more stock in desperation. Would Bank of America, which just weeks earlier had reported a record second-quarter loss of $8.8 billion, go the way of Bear Stearns or Lehman Brothers?
It was starting to smell like 2008. Hotshot BofA investment bankers gaped at $14 restricted stock units, granted in 2010 and early 2011, which on paper had lost half of their value. They began thumbing smartphones for contact info of potential alternative employers. Managers interrupted vacations to rush into the office and calm valuable dealmakers.
Calm of a temporary sort returned two days later, thanks to a theatrical Buffett-ex-machina intervention. Three years ago, Bear was sold for scrap, while Lehman was allowed to collapse into bankruptcy, setting off a global financial crisis and recession. Announced on Aug. 25, Buffett’s purchase of $5 billion in BofA preferred stock—on typical only-for-Warren terms, including a $300 million annual dividend—allowed the bank to edge back from the abyss, much as Buffett’s $5 billion vote of confidence arrested a run on Goldman Sachs (GS) stock in 2008. On Sept. 6, only hours after he sat for an exclusive interview with Bloomberg Businessweek, BofA Chief Executive Officer Brian T. Moynihan grabbed attention again by reshuffling his management ranks, elevating a pair of new co-chief operating officers and ousting Sallie Krawcheck, the high-profile head of wealth management. After all the excitement, the bank’s shares were up 19 percent from their nadir.
For now, Bank of America will not go the way of Lehman or Bear. It has $400 billion in cash and liquid investments and, more important, with $2.3 trillion in assets, it exemplifies the sorry concept of “too big to fail.” No matter what anyone says to the contrary, the U.S. government cannot afford to allow a financial institution of that size to go down and drag the rest of the country with it. BofA’s difficulties are too complex, however, to be solved by Buffett swashbuckling, executive replacements, or the retention of a really sharp lawyer. America’s biggest bank is inextricably intertwined with a still-debilitated U.S. housing market and an unemployment rate stuck painfully above 9 percent.
“Bank of America is the purest reflection of the United States economy of any of the largest financial institutions,” observes John A. Kanas, the chief executive officer of privately held BankUnited (BKU). BofA owns or services one in five home loans in the U.S., operates more than 5,700 retail branches, and serves 58 million customers. “As America goes,” says Kanas, “so will Bank of America.”
Then there’s Countrywide Financial, the worst corporate acquisition in living memory. BofA’s former CEO, Kenneth D. Lewis, bought the California subprime cesspool in 2008; its stench has permeated the Charlotte-based bank ever since. Rampant fretting over whether BofA has sufficient capital and needs to sell more stock traces primarily to fear that it can’t quantify its mounting write-offs and losses connected to hundreds of thousands of mortgages gone bad. So far, the aggregate Countrywide damage exceeds $30 billion.
“Obviously there aren’t many days when I wake up and think positively about the Countrywide acquisition,” Moynihan said on Aug. 10 during a conference call arranged to reassure anxious investors. Even some of his loyal aides concede that the call, like a series of other pronouncements he has made this year, didn’t comfort many uneasy money managers. Moynihan received his CEO stars in a battlefield promotion in December 2009, after Lewis was perceived as losing investor confidence. A compact 51-year-old former rugby player at Brown University, he has admirers who praise his herculean work ethic and intelligence. Charismatic he is not. Moynihan displays little if any humor in public and swallows many of his words. His out-of-earshot nickname within the bank, according to several employees, is “the Mumbler.” Asked for a self-evaluation during the Aug. 10 conference call, he said: “I think my performance with the management team in terms of transforming the company, I think, has been strong. Our performance on the share performance has not been strong.”
More serious than his bouts of verbal artlessness, Moynihan has overpromised on critical occasions, most notably in predicting prematurely that he would raise the bank’s penny-a-share dividend this year. Such mistakes have obscured his reasonable attempt to remake the bloated organization he inherited. To his credit he is different from the generation of hubristic bankers typified by Lewis, 64, and former Citigroup (C) CEO Sanford I. Weill, 78. During a prolonged era of bipartisan antiregulatory ideology, the Lewis-Weill cohort built the behemoths that were too big to manage and ultimately too big for Washington to allow to go under. The instability of those institutions contributed to the panic of 2008 and its messy, unfinished cleanup.
Moynihan, who for six years toiled as Lewis’s lieutenant, seems determined to learn from his former boss’s mistakes. The younger man came into his job planning to sell off extraneous assets acquired by Lewis. In the process he has made the bank a more focused institution that in the long run ought to be less dangerous to the financial system. Whether he has the dexterity to survive the current crisis and complete the task is an open question.
In the space of only a dozen years, Bank of America transformed itself from an unremarkable regional business into a financial supermarket of gargantuan proportions. Charlotte, in turn, grew into the country’s second-biggest banking center after New York.
Lewis, who never concealed his Southerner’s disdain for hifalutin Wall Street types, capped an extraordinary acquisition spree in 2008, first by absorbing Countrywide, a subprime-mortgage factory on the verge of bankruptcy. Then, with encouragement from the Bush Administration, he took over Merrill Lynch, the faltering brokerage and investment bank. Merrill turned out to be Lewis’s undoing; he lost his job in 2009 when questions arose over whether he fully disclosed its precarious financial condition as he pushed BofA shareholders to approve the $29 billion deal.
Moynihan had joined the ballooning BofA in 2004, when Lewis paid $47 billion for FleetBoston Financial, itself the product of rapid-fire mergers and acquisitions. The Fleet executive had a law degree from the University of Notre Dame but set his sights higher than the legal department. Many of his Boston-based former colleagues couldn’t—or chose not to—adjust to life under the notoriously demanding Lewis. Moynihan adapted. Years later, in his 2005 book Winning, former General Electric (GE) Chief Executive Officer Jack Welch held him up as a model of corporate stamina: “He showed exactly what you should show if you want to survive a merger—enthusiasm, optimism, and thoughtful support.”
At Bank of America, Moynihan didn’t specialize. Like a leather-helmeted footballer of yore, he played offense and defense and, in a pinch, came in to punt. To make absolutely sure he got no sleep, he often commuted to BofA’s large New York outpost from Boston, where his family—wife, Susan Berry, an attorney, and three young children—remained. His dedication inspires awe in the office. “Flash or pizzazz isn’t what clients want,” says Purna Saggurti, Bank of America’s chairman of global corporate and investment banking. “Clients want content and a trusted adviser.”
As Lewis’s grip on his empire loosened in 2009, Moynihan, lacking deep roots in Charlotte or a proven CEO’s credential, was a dark horse candidate to succeed him. But the bank’s directors were feuding, and other candidates fell away. In December, Moynihan walked into a New York hotel room to meet with the board of directors’ search committee. He held a single sheet of paper on which he had written a strategic vision that actually could have fit on a note card: enough already with the acquisitions, let’s get back to banking (or words to that effect). He got the job.
Lewis hosted a large ceremony in Charlotte to introduce the new CEO. “Many of you know him,” the outgoing chief executive said of Moynihan, “because he’s been in so many different jobs. And so, hopefully, he’ll be in this job much longer than the last three or four.” The audience of Bank of America employees, many wearing the company’s red-white-and-blue flagscape lapel pin, laughed. Standing to the side of the auditorium stage, Moynihan smiled tightly. The backhanded compliments continued. “Another unique characteristic about him,” Lewis noted, “is that he wanted the job.” With that inauspicious endorsement, Moynihan took control of a vast assemblage of businesses, which collectively had received federal cash injections totaling $45 billion and appeared to be on life support.
Then, with miraculous speed, Merrill began to recover. The acquisition that brought down Lewis became a surprise turnaround story. Federal bailout money was repaid. In April 2010, to everyone’s relief, the rookie CEO announced a first-quarter profit of $3.2 billion.
On a less happy note, Countrywide, a relative detail in 2008, was metastasizing into a disaster. When speaking privately, Bank of America executives will now acknowledge that Countrywide behaved deplorably during the real estate frenzy. In June 2010, BofA agreed to pay $108 million to settle federal charges that Countrywide overcharged mortgage customers. The firm “profited from making risky loans to homeowners during the boom years, and then profited again when the loans failed,” the Federal Trade Commission asserted. As a formal matter, BofA didn’t admit or deny the allegations, saying instead that it agreed to the settlement “to avoid the expense and distraction associated with litigating the case.”
The expense and distraction were just beginning. In the fall of 2010, with consumer complaints about mortgage abuses increasing, BofA temporarily halted foreclosures across the country. Moynihan said the bank was modifying Countrywide mortgage terms to keep people in their houses—20,000 modifications a month by late 2010. Contrary to expectations, though, home prices continued to slump in many areas, and overall economic growth remained weak, despite the Federal Reserve’s policy of keeping interest rates essentially at zero.
New threats came into focus. Even as state and federal prosecutors revved up investigations of fraud in the issuing and servicing of loans by Countrywide and its former competitors, other antagonists filed complaints. Fannie Mae (FNMA) and Freddie Mac (FMCC), the quasi-governmental housing finance companies, argued that millions of mortgages they bought as part of their mission to spur homeownership were turning out to be rotten. Fannie and Freddie wanted Bank of America (and other lenders) to buy back billions in defective loans. In addition, there were unhappy institutional investors that had purchased mortgage-backed securities, a type of bond assembled from bundles of home loans. When broke borrowers stopped paying on the mortgages, the bonds defaulted. Investors wanted compensation. On Oct. 18, 2010, one bondholder group led by BlackRock (BLK) and Pacific Investment Management (Pimco) sent BofA a stern letter demanding the bank buy back mortgages packaged into $47 billion of bonds. There was no reason to think the BlackRock demand would be the last of its kind.
A day later, BofA announced an $872 million third-quarter 2010 provision to resolve mortgage repurchase claims. That compared with $1.25 billion in the second quarter and $526 million in the first. Moynihan tried to allay nervousness over a perpetually open spigot. “It’s a half billion, half billion, half billion,” he said during an investor conference call. “Those are the kinds of numbers that would be more recurring.” In other words: Half a billion dollars per quarter may seem like a lot to ordinary folk, but we can handle it.
Not that Bank of America would surrender those half-a-billions without a fight. “It’s day-to-day, hand-to-hand combat,” Moynihan told an investor conference in New York in November 2010. All the same, he said in December, the bank planned to increase its dividend as fast as possible—a signal that its capital levels were sound. “I don’t see anything that would stop us,” he added. In January 2011, he had yet more encouraging news: The bank would take an additional $3 billion provision to settle claims from the government-sponsored enterprises (GSEs) Fannie and Freddie. “We are pleased to put the GSEs behind us this quarter,” Moynihan said on Jan. 21.
He spoke too soon. “Brian, while he is a very experienced executive, is an inexperienced chief executive,” notes BankUnited CEO John Kanas, a Moynihan fan. “He has made a couple of political mistakes, overpromising.”
On Mar. 23, Bank of America admitted in a regulatory filing that the Federal Reserve had rejected its request for a dividend increase in the second half of 2011. Among the four largest U.S. lenders, a group rounded out by JPMorgan, Citigroup, and Wells Fargo (WFC), BofA was the only one that didn’t announce a higher dividend after the Fed reviewed the companies’ financial health in March. In an interview with Bloomberg News, Jonathan Hatcher, a credit strategist at Jefferies (JEF) in New York, called the Fed action “a soft warning shot” across Bank of America’s bow.
More warnings followed. In April, BofA announced a $1.6 billion deal with Assured Guaranty (AGO) to resolve claims tied to tainted mortgage-backed securities the insurance company had covered. Outstanding mortgage-buyback demands climbed to $13.6 billion, the bank said the same month. Then, in May, it conceded in a regulatory filing that the cost of private-investor demands might rise to between $11 billion and $14 billion, or $4 billion more than the previously publicized range. Later in May, Moynihan said that the settlement with Fannie Mae might have sprung a leak, as the larger GSE stepped up its buyback demands. “We still have some work to do” on resolving Fannie Mae demands, Moynihan conceded. In June, BofA said it agreed to pay $8.5 billion to settle claims by the BlackRock-Pimco group of bondholders.
Bank of America generates an enormous amount of revenue—$111.2 billion in 2010—so it can afford to settle a lot of liability claims. “The problem,” says William B. Smith, the CEO of Smith Asset Management, a New York hedge fund, “is the unknown.” By midsummer it became apparent that no one, including Bank of America, understood the ultimate damage attributable to Countrywide.
Smith Asset Management, nevertheless, owns BofA stock. “For those of us who are bullish, we don’t believe the mortgage hit is crippling,” William B. Smith says. “Those who are bearish believe it is.” Like a number of other investors, he takes solace from market analysis showing that BofA’s breakup value exceeds its current market value of about $76 billion. “Tear this thing apart after you get down the road a bit,” says Smith, and the stock could triple in value.
That’s not what Bank of America’s management or its 285,000 employees want to hear. Nor does the notion that Bank of America might be worth more dismembered provide any consolation to hundreds of thousands of homeowners behind on their mortgage payments, some of whom accuse BofA or its blacksheep subprime-mortgage unit of mistreating them. “They were greedy. … It was a bad decision [to acquire Countrywide],” says Don Barrett, a plaintiffs’ lawyer in Lexington, Miss., who is representing allegedly defrauded borrowers. “If Bank of America is going to survive, they’d better get closure. They need closure with investors, but they also need closure with the legitimate borrowers.”
Brian Moynihan’s private conference room on the 58th floor of the Bank of America Corporate Center in downtown Charlotte has the usual photo of its occupant with the incumbent President, along with other CEO knickknacks. Moynihan has draped a canary-yellow T-shirt where every visitor can see it. “Grind Together, Shine Together,” the black lettering on the shirt instructs, and Moynihan presents himself as a grind-it-out kind of guy.
He recognizes that he sees one company, while Wall Street lately sees another. “We have the strongest capital we’ve ever had in the company for decades,” he says. “We have the strongest liquidity.” He sounds frustrated. The bank has $115 billion in what is known as Tier One common equity, which translates to a capital ratio of 8.2 percent under today’s rules. That’s more than enough to meet current requirements and puts BofA well within shooting distance of tougher international standards that will be phased in over coming years, Moynihan says. (“Litigation aside, there’s nothing wrong with this company,” says Paul Miller, a former examiner for the Federal Reserve Bank of Philadelphia who is now an analyst at FBR Capital Markets (FBRC) in Arlington, Va.)
How will Moynihan close the perception gap?
“We have to keep educating and pounding and pounding and pounding,” he says. “The No. 1 thing for me was to make the company clearer, more focused, get away from the acquisition heritage of big is great, as opposed to great is great.”
No question he’s slimmed the bank down. He has sold off assets worth nearly $40 billion. These include stakes in a bank in Brazil ($3.9 billion) and one in Mexico ($2.5 billion); a $10.9 billion investment in BlackRock; a $2.3 billion portion of an insurance company; more modestly valued credit-card portfolios in the U.K., Spain, and Canada; and, most recently, half of Bank of America’s stake in China Construction Bank, which sold for $8.3 billion. The Lewis-era binge left BofA with all kinds of pointless overhead. “Nobody sat down and said, ‘We want 63 data centers.’ We inherited 63 data centers,” says Moynihan. He intends to get that down to the single digits.
He frames the Sept. 6 management shake-up as a streamlining maneuver. Where there had been no chief operating officer, now there will be two, promoted from within: David C. Darnell will oversee businesses responsible for serving individual customers, including deposits, credit cards, home mortgages, and wealth management. Thomas K. Montag will supervise operations related to corporations and institutional investors. “They are accountable now for delivering our entire franchise to all our customers and clients,” Moynihan said in a written announcement. Joe Price, who had been president of consumer and small business banking, was ousted along with Sallie Krawcheck, the former wealth-management chief.
Moynihan is in no mood, however, to apologize. He says he has no regrets about promising to raise the dividend and then not being able to follow through. He waves off the criticism as missing the larger point that shareholders will benefit in the long run from a stronger, better capitalized bank. Similarly, he dismisses suggestions that he’s an ineffective public communicator. His job is to make sure that every employee understands that at all times they should be serving one of the bank’s three customer groups: individuals, companies, and institutional investors. Because he has pounded this home so consistently, he adds, “There’s 285,000 people could probably give that speech right now.” (Or maybe fewer. Moynihan has announced 6,000 layoffs so far this year, with more to come.)
The CEO doesn’t utter the word “Countrywide” voluntarily. He won’t comment on one option—putting the unit into bankruptcy—and he refers to the mess in shorthand: “We have to keep taking uncertain risks and eliminate them, and that’s what we’ve been doing in the mortgage area.” For Countrywide details, he recommends talking to Gary Lynch.
Bank of America’s top in-house lawyer works in a serene sanctum high above Sixth Avenue in New York. The room features cool white marble and white leather. Lynch has made a career of remaining unruffled—at the SEC during its 1980s insider-trading investigations, later as a partner at the New York corporate law firm Davis Polk & Wardwell, and then as the senior-most attorney at investment banks Credit Suisse First Boston and Morgan Stanley (MS).
It’s no wonder that Moynihan hired Lynch, but is the attorney still glad he moved over to Bank of America? Lynch laughs, a public relations man holds his breath, and the lawyer says yes.
With professorial precision he proceeds to sort the categories of legal risks facing BofA into three “buckets.” Over time, he explains, the bank can gradually empty each bucket. First, there are “representations and warranties” claims, such as those made by the GSEs and the BlackRock-Pimco bondholder group. Those parties want BofA to buy back mortgages allegedly based on false information about borrowers or property. Bank of America has negotiated compromise payments for most of the reps-and-warranties claims.
Bucket No. 2 contains fraud lawsuits filed by investors who bought mortgage-backed securities, which have lost value. A lawsuit filed Aug. 8 by American International Group (AIG), the New York-based insurance giant, sits in that bucket; AIG seeks damages of $10 billion. Lynch says the bank will fight the vast majority of such suits. “I’d much rather be sued by AIG than by someone who has never purported to be an expert on mortgages and risk management,” he notes. His point is that AIG is a sophisticated financial player that should have known that subprime-backed bonds could explode.
Finally, there’s a bucket for government allegations that Countrywide generated fraudulent foreclosure documents. BofA and other large lenders are skirmishing with the 50 state attorneys general in hopes of reaching a mass settlement whose collective price tag has been estimated at $20 billion.
Sweeping a long arm over his imaginary litigation receptacles, Lynch seems sure of himself. Statutes of limitation are running out, and that’s why so many lawyers rushed to the courthouse this summer, he says. “We’re comfortable that these securitization cases will go away or be settled for cents on the dollar,” he adds. “At the end of the day, do we have ample capital to get through this? Absolutely.”
“If someone is going to say, ‘O.K., Counselor, tell me exactly what you’re going to pay out,’ I can’t do that, and I wouldn’t try,” Lynch acknowledges. What’s more, he says, the mortgage litigation won’t get resolved in three months or six months or a year. “Past cases of this type have been working through the process for years.”
The problem, from his clients’ perspective, is that even when Bank of America says it has something resolved, new doubts clutter the bucket. The state AGs’ settlement seems, in broad outline, like a reasonable idea. Big lenders fork over cash to make borrowers whole and modify the terms on some mortgages so people can keep their homes. But lately, attorneys general in New York, Delaware, and Nevada have broken ranks, saying they don’t want to rush to a truce because they’re not through investigating lenders’ misbehavior. Moreover, the New York prosecutor, Eric T. Schneiderman, has challenged the propriety of the $8.5 billion settlement with private bondholders, casting uncertainty on that pact, too.
For all the angst over Bank of America on Wall Street and in the media, regulators at the Federal Reserve and Treasury Dept., speaking privately because they are not authorized to comment on particular banks, say they have watched Moynihan’s performance and are mostly pleased by what they’ve seen. In fact they applaud his shrinking the company and similar moves by some of his competitors.
One of the paradoxes of the 2008 crisis has been that, in its aftermath, a U.S. financial industry overpopulated with institutions considered too big to fail became even more consolidated. Mergers such as Bank of America’s acquisition of Merrill and Countrywide, and JPMorgan’s absorption of Bear Stearns and Washington Mutual have produced a quartet of megabanks that together hold $7.7 trillion in assets, or 56.8 percent of the U.S. total, compared with 45.2 percent of the total before the crisis.
Even with this added consolidation, and the potential risk it perpetuates in the event of a true investor or depositor run on any of the megabanks, regulators say there has not been much for them to do about Bank of America’s difficulties. New oversight tools created by the Dodd-Frank financial reform legislation enacted in 2010 are still being crafted. And industry lobbyists are still trying to blunt rules on how much capital banks must hold, how they sell mortgages, and what kind of trading they can do for their own accounts. To avoid future taxpayer bailouts, the law required major banks to submit “living wills,” or plans for how they could be efficiently dismembered in dire circumstances. But details on the living-will process are still being debated; no wills have been submitted to Washington. (Regulators say Bank of America hasn’t gotten into living-will territory, because the bank has cash on hand and the ability to borrow more.) So far the Dodd-Frank law’s perverse effect has been to heighten uncertainty without disentangling the combinations of investment banking with consumer and commercial banking that proved so perilous in the wake of the housing bubble.
One positive change is that there are more cops walking the banking beat. About 30 examiners from the Fed’s Richmond (Va.) branch are assigned full-time to monitoring Bank of America, up from 14 in 2007. Fed staff members say they are able to give closer scrutiny to the bank’s securities and loan portfolios, as well as the risk associated with its assets and the adequacy of its capital. In early summer, when Fed officials requested options BofA might consider if overall economic conditions seriously eroded, the bank responded that one possibility would be to issue a separate class of shares linked to the performance of Merrill Lynch, according to BofA. Moynihan does not think such a step will be needed and similarly has no plans to sell more BofA common stock, his aides say.
While Fed examiners are supposed to be keeping an eye out for reckless practices within BofA, there’s a danger that other government officials and politicians could hasten a fresh financial meltdown as they seek their pound of assets from Bank of America. The state-AG foreclosure probe has identified troubling past practices, but the handful of prosecutors holding up a resolution could jeopardize the prize they desire. Likewise, Fannie Mae and Freddie Mac, two of BofA’s other main antagonists, are each almost 80 percent-owned by U.S. taxpayers as a result of rescues at the depths of the financial crisis. The GSEs are “we the people”; if they help take Bank of America down, taxpayers will have to mop up. On Sept. 2, the Federal Housing Finance Agency, the Washington regulator of Fannie and Freddie, joined the fray. In its own brace of lawsuits, the FHFA accused Bank of America and 16 other lenders of misleading Fannie and Freddie about billions of dollars of mortgage-backed securities.
The problem for Moynihan, says Lou Barnes, “is that everyone is suing him, he can’t know when the suits will stop, and meanwhile—hello?—the economy isn’t bouncing back, and it’s damned tough to get a home loan approved out here.” Barnes, a banker and credit analyst at Premier Mortgage Group in Boulder, Colo., argues that Moynihan “looks to be doing as well as any little Dutch boy can—sticking his fingers in the dike.”
But more cracks keep opening up. Barnes ticks off the latest statistics from Lender Processing Services, a major home-loan servicer: 4.1 million loans nationwide are 90 or more days delinquent or in foreclosure; delinquency rates are twice their historical norm; foreclosure rates are eight times higher than the historical average; more than 40 percent of 90-days-plus delinquent loans have not made a payment in more than a year.
BofA is more exposed to those scary figures than any other bank. Moynihan “has got to know there are more losses ahead, enough to kill a bank,” says Barnes. “No model exists for what happens next.”