BofA: The Credit Crunch Takes Its Toll

Weakness at the financial giant's investment banking unit is dragging down solid results from its traditional banking business

After missteps on Wall Street, Bank of America (BAC) says it will make big changes in its investment banking business to stop it from spoiling the big bank's success on Main Street.

On Oct. 18, BofA reported earnings of 82 cents per share, far lower than the $1.06 analysts were expecting according to Reuters Estimates. Profits fell 32% from a year ago, when BofA earned $1.18 per share.

BofA, a bank with 5,700 branches nationwide, had been beefing up its focus on high finance. But the summer's credit disruptions took a heavy toll. Net income from its Global Corporate and Investment Banking unit fell 93% from $1.43 billion a year ago to just $100 million in the third quarter.

BofA's chairman and chief executive Kenneth Lewis is now hinting at big changes to the investment banking business.

"While some of the underperformance was difficult to avoid, we believe we should have performed better," Lewis told analysts Oct. 18. He said he would be examining those businesses closely. "The likelihood of changes ... is very high," he said.

He said he didn't go into detail, but suggested BofA may scale back some lines of business. Asked whether BofA might buy up another investment banking firm, perhaps to add more talent and expertise, Lewis said no. "I've had all the fun I can stand in investment banking," he said, "so to get bigger ... is not something I want to do."

BofA didn't see the same losses as its big bank rival Citigroup (C), which was much more exposed to credit market problems. But BofA was hit much harder than expected. It lost $607 million in trading revenue and lost $527 million on structured products, which include the mortgage-backed debt that has caused so much concern. The company's hedging strategy — its attempts to balance potential losses with gains in other areas — broke down in the unpredictable market conditions this summer.

Deutsche Bank (DB) analyst Mike Mayo wrote "the quarter could have been worse." It "compares favorably to Citigroup, but not quite as well versus J.P. Morgan."

The three outfits are often compared because they're all large financial conglomerates, with investment banking businesses alongside big U.S. retail banks. On Oct. 15, Citi reported earnings per share of 47 cents, a 57% drop from a year ago. On Oct. 17, JPMorgan Chase (JPM) reported earnings of 97 cents per share, up from 92 cents a year ago, and better than analysts were expecting.

At Bank of America, as at its big rivals, diversification can be a strength. "Our business model by design acts as a defense for what occurred in the third quarter," Lewis said. Problems in one area can be offset by strength elsewhere.

In the third quarter, BofA's traditional, Main Street banking business appeared to hold up well.

Sale of retail products, like mortgages and new accounts, were up 12%. Retail deposits rose 4%.

BofA has been aggressively boosting its mortgage business, taking up market share as many other non-bank lenders have disappeared or cut back, hurt by problems with subprime and other risky mortgage debt. First mortgage originations were up 27%. Another ambitious growth area was sales to small businesses, which rose 24%.

Subprime issues, the housing decline and a weak economy have raised concerns about Americans' ability to meet their debt payments, whether on mortgages, credit cards or business loans. BofA's credit losses were up slightly, but not enough to worry anyone, Lewis said. BofA is losing money on borrowing to homebuilders, but otherwise its credit quality is "pristine," he said.

As the third-quarter earnings season continues, BofA is one of many financial companies showing big losses from recent credit market conditions.

E*Trade Financial Corp. (ETFC) reported a third-quarter loss of 14 cents on Oct. 18, vs. earnings of 35 cents a year ago. Revenues fell 45% as the firm reported $384 million of losses on securities and loans. The bank Washington Mutual (WM) earned 23 cents per share, vs. 77 cents a year ago, and reported loan losses of $967 million. By late morning on Oct. 18, WaMu shares were off 7.7% and E*Trade's stock had fallen 7.2%.

BofA shares were faring better, but were still down 3.5% by late morning, trading at $48.30 per share.

One question for BofA is how soon it can turn its Wall Street operations around. Are the credit market disruptions a wound that will heal quickly, or will they fester into next year?

According to Stifel Nicolaus (SF) analyst Christopher Mutascio, the weakness will linger for some time. "We do not believe this will be just a [third quarter] event," he wrote. However, Jeff Harte of Sandler O'Neill said businesses hurt by the credit crunch could find ways to bounce back. Market volatility "is not a one-way street and could lead to revenue upside in quarters to come," he wrote.

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