Mortgage Line Stands Out In the Wrong Way at B of A

Bank of America Corp. tried hard last week to cast its first-quarter results as its long-awaited turning point, but a resurgent problem spoiled the party: mortgage woes.

All but one of B of A's business units finished the period in the black, but its mortgage and insurance business posted a loss of $2.07 billion on higher losses in home equity lending, declining volumes and shrinking margins. Though chief executive Brian Moynihan preached about a strong recovery Friday, fixing those mortgage issues was top of mind in his discussions with analysts, and he cautioned that it could take several quarters for losses to abate and for the company to start expanding its mortgage and home equity books.

"The mortgage portfolio isn't going to [grow] all that fast, and I wouldn't expect the home equity portfolio to grow," Moynihan said. "I'm not sure we'd expect either mortgage or home equity to move dramatically from where we are at this point, in terms of dollar amounts" or an impact on the bottom line.

But B of A has no plans to backpedal from a strategy of being a leading mortgage lender, the CEO said. "It is a core product for us, and we're still in the business."

Moynihan said B of A is adjusting to a shifting customer base, particularly in home equity, where the $2 billion of originations in the first quarter was half that of a year earlier. Projecting continued declines in home equity volume, he said the product is becoming an offering that best suits the company's "more affluent customers," who are using lines to fund education and other personal pursuits.

Anthony Polini, an analyst at Raymond James & Associates, predicted that the home equity portfolio "will be in run-off mode for years" since the product is no longer a viable vehicle for leveraging debt. "Going forward, home equity will be available, but only to people who, in some respects, don't need it."

B of A beefed up its mortgage operations through the July 2008 purchase of the troubled Countrywide Financial Corp., and analysts have long wondered when the company would suffer indigestion from the buyout. (Moynihan said Friday that B of A will let its Countrywide mortgages run off.)

The ugly overall numbers in the mortgage operations seemed to signal the reckoning had only just begun. The operations' first-quarter loss was nearly double that of the fourth quarter and 31% worse than a year earlier. A $3.6 billion loan-loss provision was far greater than the $1.4 billion set aside in the fourth quarter and the $228 million a year earlier.

Pressure came from multiple fronts. Mortgage revenue fell 9.2% from the fourth quarter and 54.7% from a year earlier, to $1.5 billion. Originations fell 19.7% from the fourth quarter and 18.4% from a year earlier, to $69 billion. Production income fell as a result of lower volume and rising expenses tied to repurchases from the Federal Housing Administration.

Home equity net chargeoffs rose 53.6% from the fourth quarter and 42.6% a year earlier, to $2.4 billion, though executives said some of the increase was tied to an accounting rule requiring certain home equity and credit card receivables come back to the balance sheet. In comparison, JPMorgan Chase & Co. reported Wednesday that home equity net chargeoffs fell 4.3% from the third quarter and rose just 3% from a year earlier, to $1.1 billion.

Deutsche Bank analyst Matt O'Connor warned that losses in home equity could increase "sharply" in his note to clients on B of A's results. Observing that the increase was in part tied to loan modifications, he said it "is unclear how much more will be incurred."

Polini countered that the worst-case scenario might be another $5 billion in chargeoffs if Congress toughens writedown requirements, which would amount to a "cleanup charge" for Bank of America. "As the economy improves and commercial loan growth kicks in early next year, there will be more and more offsets," he said.

Restructurings of troubled debt have accelerated as the $2.3 trillion-asset Charlotte company has attempted to reinvent itself as more consumer-friendly under Moynihan's leadership. B of A has modified more than 550,000 mortgages since January 2008, including 32,900 under the Home Affordable Modification Program. Roughly $813 million in first-quarter chargeoffs were related to loan modifications, but executives said reserves were already established for the majority of those chargeoffs.

The mortgage problems partly overshadowed an otherwise good showing for B of A, which earned $2.83 billion, reversing two straight quarters of losses. Every other business, even the credit cards business, made money. Earnings per share of 28 cents exceeded the average analyst estimate by 19 cents, according to Thomson Reuters. Revenue, however, fell 11% from a year earlier, to $32 billion, though last year's number included hefty gains from valuation changes in Merrill Lynch & Co. debt.

Overall, Bank of America set aside $9.8 billion to cover loan losses in the quarter, down 3% from the fourth quarter and 26.9% from a year earlier.

Moynihan talked as though B of A had seen the worst in its cards portfolio. "We feel we've broken the back of it, and it is coming the right way — from the front end, from the early stage," he said.

Neil Cotty, who has been serving as interim chief financial officer, sounded similarly upbeat about chargeoffs in the commercial book, saying that it still appears as though those losses peaked in the third quarter.

Earnings for global banking and markets, which includes the former investment banking operations at Merrill Lynch, rose 28.2% from a year earlier, to $3.2 billion, thanks largely to sales and trading.

Global commercial banking rebounded, earning $713 million, compared with a $30 million loss a year earlier.

Moynihan was optimistic about the potential of increasing commercial lending.

The company feels "better now than we did a quarter ago," he said.