Bank of America: Troubles Might Just Be Starting

Midday observations:
Bank of America joining Citiin essentially announcing they are eliminating their share buyback program (to be technical, the headline said "only limited share buybacks until late '08"). It's likely that their hefty $2.56 dividend (5.3% yield) is safe, for the time being.

But there are broader problems with the poor quarter for B of A: it may not be the last one. Analyst Christopher Mutascio at Stifel, Nicolaus said "we do not believe this will be just a 3Q07 event. Weakness in debt underwriting and sales & trading of credit and structured products are likely to last for some time, in our view."

With all this mumbo-jumbo about losses and credit quality, let me walk you through what happened at Bank of America. There were two big problems:

1) Writedowns. A writedown involves reducing the book value of an asset; it's typically done when the asset is overvalued compared to current market prices. The company wrote down:

a) $607 m (9 cents per share) on losses related to credit trading--due to the "breakdowns in traditional pricing relationships" and widening of credit spreads during the quarter.

b) $247 m (4 cents per share) on losses from leveraged buyout (LBO) loans

c) $527 m (8 cents per share) on losses from Collateralized Debt Obligations and other structured products. CDOs are securities backed by pools of assets, in some case mortgage-backed securities, that divide up the credit risk by issuing different bundles. Much of the losses here are due to the subprime meltdown.

2) Credit quality declined. Credit is just money loaned out by the bank; the quality--the creditworthiness, or ability of the borrower to repay the loan--has deteriorated for a number of the bank's borrowers.

For example, the company's nonperforming assets increased 41% sequentially (up nearly $1 billion). Nonperforming assets are assets that are not producing any income, but are not yet written off as a complete loss. Residential mortgage, home equity and commercial (domestic) loans were the main reason quality declined.

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