Bank of America Shrinking Assets Puts $2.8 Billion Hole in Moynihan Target

Bank of America Corp.’s $33 billion of asset sales last year, designed to help meet international capital standards, may slice at least $2.8 billion from 2012 profit that the firm also needs to reach its target.

That’s probably more than the bank earned before taxes in all of 2011, a year marred by the worst quarterly loss for the Charlotte, North Carolina-based company. The amount, based on estimates compiled by Bloomberg, reflects the loss of income from divestments including a stake in a Chinese lender, a Canadian credit-card unit and an insurer of foreclosed homes.

“There are consequences to downsizing the balance sheet, and that’s lower interest income,” David Trone, an analyst at JMP Securities LLC, said in an interview. “Management gets into situations where they have to make uneconomic decisions. It reflects how intense the pressure is for them.”

Chief Executive Officer Brian T. Moynihan boosted asset sales at the second-biggest U.S. bank from $20 billion in 2010 to avoid issuing stock that would dilute current shareholders. He may end up doing that anyway: With fewer unwanted assets left to sell, Moynihan is now more reliant on earnings to generate capital. Selling shares or even crucial businesses can’t be ruled out if new mortgage losses wipe out profit.

“The risk of having to initiate core asset sales or a partial breakup of the company is rising with the persistent pressure on core earnings,” said Todd Hagerman, an analyst at Sterne Agee Group Inc. in New York, in a Dec. 21 note.

Selling Pieces

Moynihan, 52, started selling pieces of the bank as costs from shoddy loans inherited in the 2008 acquisition of Countrywide Financial Corp. soared to $40 billion. He faces another $12 billion to $32 billion in such expenses, according to a Jan. 5 note by Keith Horowitz, an analyst at Citigroup Inc. in New York, who rates the lender a “buy.” Trone, with a “market perform” rating, sees as much as $40 billion more.

While the lender probably can manage these charges over time, regulators could force Bank of America to raise capital, said a person with knowledge of the firm’s planning. The bank is more likely to choose a stock sale than sell a core business, particularly if shares rise above $10, said the person, who declined to be identified because the process is private. The stock rose 2.3 percent to $6.63 at 10:09 a.m. in New York.

Quarterly Results

Bank of America reports fourth-quarter results tomorrow. The firm may post pretax profit of $3.68 billion, according to the average of estimates by 13 analysts surveyed by Bloomberg. Full-year totals are likely to be much less because losses in the first nine months were $2.66 billion.

According to analysts’ estimates, Bank of America forfeited $1.5 billion a year in pretax earnings when it sold its non-U.S. credit-card unit. Also gone is the bank’s stake of about 10 percent in China Construction Bank Corp. (939), that nation’s second- largest lender, which paid a $774 million annual dividend; the Balboa insurance unit, which contributed $410 million, and $75 million earned from shares in asset manager BlackRock Inc.

Jerry Dubrowski, a Bank of America spokesman, confirmed Bloomberg’s estimate of the income drop. He declined to say whether the bank would sell core assets or offer new shares to investors if pushed by regulators to raise more capital.

More earnings may have been sacrificed with the sale of private-equity stakes in NPC International Inc., the biggest U.S. Pizza Hut franchisee, and hospital operator HCA Holdings Inc. The company didn’t provide estimates on how much profit those holdings contributed.

‘Growth Company’

Moynihan told investors in March that the bank had returned to being a “growth company” and could earn $35 billion to $40 billion in pretax profit when businesses recover.

Showing how far Bank of America is from full recovery, the company probably made just $2.6 billion in pretax income for 2011, according to Bloomberg estimates, after a record second- quarter loss stemming from mortgage settlements. Analysts expect pretax profit of $16.2 billion in 2012 and $22.6 billion in 2013, about half of Moynihan’s target.

Bank of America needs the money to help reach higher levels of capital demanded by regulators as a cushion against losses from future financial crises. Under new and more stringent rules approved by the Basel Committee on Banking Supervision, the firm may have to retain more than $40 billion in earnings by 2019. The figure could drop if the bank sells more of its riskiest assets, which would cut the need for capital, Dubrowski said.

‘Earnings Power’

“It’s an important question for investors -- what’s their earnings power?” said Jefferson Harralson, an Atlanta-based analyst at KBW Inc. with a “market perform” rating on the lender. “What kinds of returns can shareholders expect?”

Bank of America, which held the title of biggest U.S. bank by assets until last year, is shrinking faster than rivals. It pared assets by $45 billion, to $2.2 trillion, in the first nine months of 2011. Citigroup (C) contracted by $22 billion, to $1.9 trillion, over the same period, selling holdings including student loans.

Moynihan is seeking to make Bank of America a leaner, more focused company amid stagnant revenue and sluggish U.S. economic growth. In the process, he’s dismantling some of the more than $130 billion in acquisitions made by his predecessor, Kenneth D. Lewis, who was criticized by investors for overpaying when he bought Countrywide and Merrill Lynch & Co. as those firms were reeling toward collapse.

‘Hot Coals’

The divestments pushed the bank’s Tier 1 capital above 9 percent by the fourth quarter, more than double the level during the 2008 financial crisis. Tier 1 capital, which includes common stock, reserves and retained earnings, is a measure of a bank’s financial strength and ability to absorb unexpected losses. The lender used proceeds to trim debt, which reduces interest costs, Dubrowski said. Long-term debt declined by $50 billion to $399 billion as of Sept. 30, the bank said in November.

“What Moynihan has been doing must be as fun as walking on hot coals, but he keeps walking,” said Greg Donaldson, chairman of Evansville, Indiana-based Donaldson Capital Management LLC, which has $500 million in assets including Bank of America shares. “There’s a grudging, arm’s-length respect for him continuing to fight.”

Moynihan told employees at a town-hall meeting in October that he had largely completed his plan to spin off name-brand holdings. The company will now focus on cutting so-called risk- weighted assets, including mortgage-servicing contracts and credit-card loans, he said.

“We’re getting to the point where the franchise we have is in the condition we want it in,” Moynihan said at the time. “There are still non-core assets we’re getting rid of, but it’s loan portfolios, things of less note, and that will take place through the next 12 to 18 months.”

Reducing Branches

Bank of America could break up a segment of its retail- banking business if regulators required a capital raise, said Thomas Brown, CEO of New York-based Second Curve Capital LLC, in a Dec. 9 Bloomberg Television interview. In June, the bank told the Federal Reserve it could reduce branches to bolster finances in an emergency, said a person briefed on the discussions.

“There’s no question that Bank of America is worth a lot more broken up than it is today,” said Brown, a former Wall Street banking analyst and now a Bloomberg contributing editor.

Meanwhile, JPMorgan Chase & Co. (JPM) CEO Jamie Dimon, 55, has said his firm, now the biggest U.S. bank by assets, would expand beyond its 5,508 locations to capture more deposits. Bank of America had 5,715 retail centers as of Sept. 30.

Merrill Lynch

Bank of America could also find a buyer for its wealth- management unit, whose 16,722 financial advisers each produce about $890,000 in annual revenue, Mike Mayo, a New York-based analyst at CLSA Ltd., said last week in an interview. Moynihan has said he won’t undo any part of the Merrill Lynch takeover, which gave the firm the opportunity to sell bank products to brokerage clients.

The CEO made other decisions last year that boosted capital while potentially shrinking profit for stockholders.

In August, Moynihan agreed to pay $300 million a year to Warren Buffett’s Berkshire Hathaway Inc. in exchange for a $5 billion investment. That deal includes the option for Berkshire to buy 700 million shares in the lender at $7.14, which could make him the biggest shareholder and dilute other investors.

The bank issued 400 million shares to investors in private exchanges for preferred securities in November and December. While the moves are dilutive, they lower interest payments, which benefits investors, the bank has said. The company has more than 10 billion shares outstanding.

New Shares

The lender may issue another $15 billion in stock this year to meet capital requirements, Matthew O’Connor, an analyst at Deutsche Bank AG in New York, said in a Jan. 4 note. Further share exchanges may happen in amounts “not expected to be material,” Bank of America said last month in a filing.

Moynihan risks further eroding his standing among investors if he issues more stock, after saying in August that the bank won’t “continue on a course of diluting our shareholders” as it had done after government bailouts in 2009.

Concern that Bank of America will issue new shares has plagued the stock, which sank 58 percent last year, the worst performance in the Dow Jones Industrial Average. This month, Bank of America has surged 17 percent, the most of the 30 companies in the Dow index, as investors bet that an improving U.S. economy will buoy earnings.

“All they have to do this year to have the stock rise significantly,” said KBW’s Harralson, “is show that the current share count is close to the eventual one.”

To contact the reporter on this story: Hugh Son in New York at hson1@bloomberg.net

To contact the editors responsible for this story: David Scheer at dscheer@bloomberg.net; Rick Green at rgreen18@bloomberg.net

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