CHARLOTTE, North Carolina Fears that Bank of America (BAC.N) will be forced to buy back billions of dollars in troubled mortgage bonds from investors overshadowed better-than-expected earnings from the biggest U.S. bank and sent its shares down 4.3 percent.
A group of eight investors accused the bank of inappropriately bundling some mortgages into more than $47 billion in bonds. Bloomberg News reported that the New York Federal Reserve and bond fund Pimco were among the investors.
Bank of America shares initially rose after the No. 1 U.S. lender by assets reported earnings that beat estimates, but turned sharply negative after the Bloomberg report.
"This repurchase issue is now elevated from the undercard to the main event," said Jefferson Harralson, Atlanta-based bank analyst with Keefe, Bruyette & Woods Inc. "It makes you think the losses on these repurchases will be higher because the litigants have significant resources and are some of the most powerful institutions in the country."
Bank of America shares were the top percentage decliners among the largest U.S. banks, closing at $11.80 on the New York Stock Exchange. That was the lowest closing price for the stock since it reached $11.21 on June 3, 2009.
In a reminder that the mortgage crisis could haunt the bank for years to come, BofA said it had received $26.7 billion in claims about faulty home loans that it might have to repurchase from Fannie Mae and Freddie Mac, the two giant government-sponsored mortgage enterprises; mono-line insurers; and private investors.
And while BofA executives said they projected the company had fielded two-thirds of all repurchase requests from Fannie Mae and Freddie Mac, they could not "reasonably estimate" the ultimate size of the requests from the insurers and private investors.
Renewed worries about whether banks will be forced to repurchase billions of dollars in mortgage bonds have coincided with partial moratoriums on foreclosures after documentation problems were found. That in turn has spooked investors who had hoped for a recovery in the banking sector.
BofA helped ease some investor fears on Monday when it said it would partially lift a nationwide foreclosure halt that began October 9 amid a public outcry that lenders had cut corners in the foreclosure process.
On Tuesday, GMAC Mortgage, a division of Ally Financial, also announced plans to resume foreclosures after suspending them in 23 states last month.
CHEVY VEGA VS. MERCEDES
BofA Chief Executive Brian Moynihan, in a conference call, downplayed worries that affidavits backing home foreclosures were improperly prepared and that incomplete documentation could lead to a spike in repurchases.
But Moynihan said the bank would not be shy about fighting back against investors whose attitude was: "I bought a Chevy Vega but I want it to be a Mercedes."
"We're going to protect shareholders against that," he said.
BofA's credit default swap spreads also widened during the afternoon sell-off, indicating investors believed the bank more likely to default on its debt. The cost of protecting BofA's debt against default for five years rose to 1.95 percentage points, or $195,000 a year for every $10 million of debt insured from 1.85 percent.
BofA option volume was also heavy on Tuesday as about 1.07 million contracts traded, 2.5 times the average daily turnover, according to options analytics firm Trade Alert.
Beyond the mortgage issues, some analysts questioned whether BofA could generate much more profit from cutting reserves for bad loans, without growth in its core business that includes an overhaul of its consumer banking unit.
"The decreasing risk provisions is something that we've seen happening at all banks. The question for BofA is whether it can continue that trend," said Heinz-Gerd Sonnenschein, strategist at Postbank in Bonn.
BofA executives said the bank expects its consumer business to recover much of the revenue lost because of the new financial reform law, but it will take time.
"This is not a snap-your-fingers-and-it-will-happen, overnight process," Moynihan said in response to an analyst question.
Earnings in the bank's deposits unit -- comprising primarily consumer banking operations -- fell 76 percent in the third quarter from a year prior.
Moynihan said the bank is concerned about changing its model too quickly and jarring customers, after spending the last year trying to reduce customer turnover that was at all-time highs.
The bank is now focused on selling more services to existing customers, rather than imposing penalty fees, he said.
Analysts said success in the transition to the new consumer bank model is not a given.
"Everybody is trying to be like Wells Fargo (WFC.N), which is the best at cross-selling of all the banks. But not everyone can execute this strategy," said Malcolm Polley, chief investment officer at Stewart Capital Advisors in Indiana, Pennsylvania.
BofA joined JPMorgan Chase & Co (JPM.N) and Citigroup Inc (C.N) in besting analysts' projections for the third quarter. Goldman Sachs Group Inc (GS.N), the dominant U.S. investment bank, also posted better-than-expected results on Tuesday.
Excluding a non-cash goodwill charge, Charlotte, North Carolina-based BofA reported earnings of $3.1 billion, or 27 cents per share. Analysts had expected 16 cents per share, according to Thomson Reuters I/B/E/S.
The bank recorded a $10.4 billion goodwill charge for its card business, previously announced, due to a new law limiting the fees banks can charge for processing debit card transactions.
Some of the bank's key traditional profit drivers continued to decline.
Net interest income -- the money the bank earns from loan interest -- fell for the fourth straight quarter. Bank executives said they expect net interest income to continue to fall for the next several quarters, though the pace of the decline is expected to slow.