Bank of America's Rosy Housing Outlook

Bank of America (BAC) is betting a recovery in home prices this year will allow it to avoid new losses on mortgage loans. That outlook clashes with the views of some independent analysts—and its own economist. Chief Executive Officer Brian T. Moynihan's credibility is riding on the outcome as he seeks to convince investors that the lender can curb costs from bad mortgages. The bank had to book $3 billion in expenses in the past two quarters because it underestimated the slide in housing values. It says it may suffer $1.5 billion in losses for every four percentage points that home-price declines exceed its estimates for a market that Moynihan told shareholders on May 11 still faces "enormous challenges."

While Bank of America does not disclose its home price forecast, spokesman Jerry Dubrowski says it is "close" to the average 1.4 percent decline predicted by 111 economists surveyed by research firm MacroMarkets. Neil Cotty, the bank's chief accounting officer, said on an Apr. 15 conference call with analysts that home prices may begin a "gradual improvement over the second half."

Cotty's view is more optimistic than the one held by Michelle Meyer, the bank's senior U.S. economist, who predicts the market won't hit bottom until 2012. Meyer, whose arrival in August from Barclays Capital (BCS) was accompanied by a news release praising her housing expertise, sees foreclosure sales as a drag in coming months. "There's a long and painful path before the housing market looks normal," she said in an Apr. 20 interview on Bloomberg Television. "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."

Each quarter, banks set aside money to cover mortgage losses, basing the amount on their outlook for the housing market and other factors. That money is deducted from the bank's earnings, so adding less to reserves increases reported profits. "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," says 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."

Home values fell 3 percent in the first quarter, according to real estate website Zillow. Stan Humphries, the firm's chief economist, says 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. Prices are close to the low reached in April 2009, according to the S&P/Case-Shiller Home Price Index. Robert Shiller, the Yale University economics professor who helped develop the index, said on Apr. 26 that values may decline "another 5 or 10 percent."

Bank of America, based in Charlotte, 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, the biggest mortgage lender during the housing bubble. Concern that those costs will swell has hurt shares of BofA, 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.

In the fourth quarter of 2010 and the first quarter of this year, Bank of America wrote down the value of a group of troubled loans, mostly inherited in the Countrywide takeover, by a total of $2.4 billion and set aside an additional $500 million to repurchase defective mortgages, all because home prices fell by more than the bank had estimated. Those expenses weakened Moynihan's credibility with investors, according to John McDonald, a Sanford C. Bernstein analyst, who says they give the impression that the bank's "assumptions around housing prices are not as conservative as they could be."

Other banks expect home prices to drop and are selling bad mortgages. Citigroup (C), 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 Apr. 27.

"Reasonable people will come to different views when looking at economic forecasts," says BofA's Dubrowski. "I don't think we're overly optimistic in our expectations for housing prices."

The bottom line: Bank of America, already burned by its upbeat home price forecasts, continues to count on more improvement than others see.

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