At Bank of America Corp., where the company’s home-price forecasts have proved too good to be true, billions of dollars of new losses are at stake along with the credibility of Chief Executive Officer Brian T. Moynihan.
The 51-year-old Moynihan, who succeeded Kenneth D. Lewis in 2010 after the worst housing market since the Depression, has tied his firm’s performance to a recovery in home prices this year -- a prediction more optimistic than one made by the bank’s own economist. Underestimating the slump in U.S. real estate led to $3 billion of expenses in the past two quarters, and Bank of America said it may suffer $1.5 billion in losses for every four percentage points that declines exceed forecasts.
Home prices may begin a “gradual improvement over the second half,” Neil Cotty, the company’s chief accounting officer, said last month. Michelle Meyer, the bank’s senior U.S. economist, predicts the market won’t hit bottom until 2012. Rival lenders and analysts say the drop could exceed 10 percent.
“If you put on a pair of rose-colored glasses with respect to the housing market, then you can defer the recognition of provision costs and buy time to earn your way out of the hole,” said Tony Plath, a professor of finance at the University of North Carolina in Charlotte who follows Bank of America. “It’s wrong, but that’s what’s going on.”
‘Long and Painful’
Meyer, whose arrival in August from Barclays Plc was accompanied by a news release praising her expertise in housing markets, sees foreclosure sales as a drag in the months ahead.
“There’s a long and painful path before the housing market looks normal,” Meyer said in an April 20 interview on Bloomberg Television’s “Bottom Line” with Mark Crumpton. “Our view is that we’ll see a 5 percent drop in national home prices this year; it could be larger. The increased share of distressed sales will continue to exert downward pressure on home prices.”
The forecast made by Cotty, 56, on an April 15 conference call with analysts is “directionally” consistent with Meyer’s, said Jerry Dubrowski, a Bank of America spokesman. Management’s projection, which uses a combination of standard indexes and the company’s own analysis, is “close” to the average 1.4 percent decline of 111 economists surveyed by MacroMarkets LLC, he said.
Home values fell 3 percent in the first quarter, according to real estate website Zillow Inc. Prices will drop as much as 9 percent this year and won’t find a floor until 2012 as foreclosures spread and unemployment remains high, said Stan Humphries, the firm’s chief economist.
“Reasonable people will come to different views when looking at economic forecasts,” Bank of America’s Dubrowski said. “I don’t think we’re overly optimistic in our expectations for housing prices. It is difficult to predict what housing prices will do, and we make a good faith effort to do so.” Meyer’s research department is independent from management, he said.
Bank of America, based in Charlotte, North Carolina, holds $408 billion of mortgages and home-equity lines. Its home-loan division has lost more than $15 billion since the 2008 acquisition of Countrywide Financial Corp., the biggest mortgage lender during the housing bubble.
Regulators later found its growth was fueled by lax lending standards, with loans marred by false or missing data about borrowers and properties. That entitled mortgage buyers Fannie Mae and Freddie Mac and bond insurers including Assured Guaranty Ltd. to demand refunds. The takeover also saddled Bank of America with $41.7 billion in troubled Countrywide loans.
Concern that those costs will swell has hurt shares of Bank of America, the largest U.S. lender by assets and the biggest servicer of mortgages. The stock’s drop of about 29 percent in the past year is the worst in the 24-company KBW Bank Index. The performance will likely be addressed at the firm’s annual shareholder meeting tomorrow in Charlotte.
Falling home prices often lead to more defaults, which in turn causes claims from mortgage investors and insurers. The company acknowledged in January and again in April that it had underestimated the severity of home-price declines.
In January, it disclosed a $3 billion settlement with the two government-sponsored enterprises, Fannie Mae and Freddie Mac. Assuming stable housing prices, the deal “largely addressed” those liabilities, the bank said, and Moynihan told investors management was “pleased to put the GSEs behind us.”
Three months later, unresolved demands for loan refunds surged $2.9 billion to a record $13.6 billion, fueled mostly by claims from Fannie Mae and Freddie Mac. The bank also agreed last month to pay $1.6 billion to settle claims with Hamilton, Bermuda-based Assured.
Home prices are “extremely unlikely” to bottom in the middle of the year, said Humphries, the Zillow economist whose Seattle-based firm tracks home prices. “We’re still seeing monthly depreciation rates at above 1 percent right now.”
A majority of the economists surveyed by Madison, New Jersey-based MacroMarkets predict prices will be flat or drop as much as 7 percent this year as foreclosures add to the supply of distressed properties.
Robert Shiller, the Yale University economics professor who co-founded the forecasting firm, said April 26 that values may decline “another 5 or 10 percent.” Morgan Stanley’s Oliver Chang is calling for a drop of as much as 11 percent.
Prices are close to the low reached in April 2009, according to the S&P/Case-Shiller Index. The measure, which Dubrowski said is one of the components used to calculate the bank’s own housing index, fell 3.3 percent in February, the biggest drop in more than a year.
Other banks expect home prices to drop and are selling bad mortgages. Citigroup Inc., the third-largest bank by assets, sold $1.1 billion in delinquent mortgages in the first quarter because the New York-based firm sees “downward pressure” on prices this year, Treasurer Eric Aboaf said on April 27.
A glut of foreclosed homes may push prices lower when their legal status is resolved, said Celia Chen of Moody’s Analytics Inc., who forecasts a 5 percent decline this year. Bank of America is among five of the largest U.S. mortgage servicers being targeted by state attorneys general for faulty foreclosure practices, which delayed some seizures and sales.
“If that’s dragged out, you could have the bottom later, and prices will continue to fall through next year,” Chen said.
The impact of lower home prices helped drive a 36 percent decline in first-quarter profit at Bank of America to $2.05 billion. The bank set aside another $1 billion to cover new demands for mortgage refunds and didn’t cut its $10 billion upper estimate of possible payments to claimants other than Fannie Mae and Freddie Mac, even after the Assured settlement reduced the pool of disputes. In both cases, the company cited falling home prices.
The added expenses “give the impression that their assumptions around housing prices are not as conservative as they could be,” John McDonald, a Sanford C. Bernstein & Co. analyst in New York, said in an interview.
The costs also weakened Moynihan’s credibility with investors, said McDonald and Paul Miller of FBR Capital Markets. The bank trades for less than 60 percent of book value per share, compared with 76 percent for Citigroup and more than 100 percent for JPMorgan Chase & Co. and Wells Fargo & Co.
“They keep telling me they’re through with most of the Fannie and Freddie losses, but last quarter we saw an increase of over 25 percent in requests, which makes me question how far they’re through the book,” Miller said. “They’re being overwhelmed.”
Miller has a “market perform” rating on the shares, while McDonald rates them “outperform,” saying that the firm’s capital will remain adequate even in a worst-case scenario.
Reflect and Revise
Bank of America’s housing-price targets are updated quarterly, allowing the lender to adjust estimates to reflect market conditions, Chief Financial Officer Charles Noski, 58, said last month in an interview.
“At any point in time, we have the opportunity to reflect the most current thinking, not only of the various indexes but of our own economists on coming to a collective view on how housing prices should behave,” Noski said. The bank later said Noski is relinquishing his post and becoming a vice chairman.
Moynihan has had other stumbles since becoming CEO in January 2010. He called his first year a period to “repair and rebuild” after a $2.2 billion loss, setting expectations for improved results. In March, Moynihan told investors at a conference in New York that the bank expected to be allowed to raise its 1-cent dividend this year. Within days, Bank of America became the only U.S. lender among the biggest four to have its capital plan rejected by the Federal Reserve.
The regulator may have been concerned that the bank’s capital could be threatened by its Countrywide loans, analysts including Frederick Cannon, director of research at KBW Inc., have said. Moynihan’s predecessor, Lewis, purchased the mortgage lender co-founded by Angelo Mozilo in July 2008.
Lewis also underestimated the fall in home prices. He predicted in June 2007 that the U.S. housing slump would end in the next month or two. Instead, values plunged 24 percent over the next three years, wiping out $4 trillion in equity and sending 3.9 million homeowners into foreclosure.
“The drag stops in the next few months,” Lewis said in a June 2007 interview with Bloomberg News. “It’s just about to be over. We’re seeing the worst of it.”
Three days after Lewis’s prediction, Bank of America analysts accurately wrote that U.S. mortgage losses were just beginning.