How the Worst Deal in the History of Finance Could Get Even Worse

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Countrywide mortgage"It's the worst deal in the history of finance." So said University of North Carolina banking and finance professor Tony Plath recently to The Wall Street Journal, in reference to Bank of America's (BAC) 2008 purchase of Countrywide Financial.

At the time, Bank of America thought the mortgage originator, priced at $2.5 billion, was a bargain, but not anymore. One estimate puts the bank's total cost of acquisition at more than $40 billion, and the fun may not be over yet.

What They Were Thinking

By late 2007, America's real estate market was obviously on the way down, but no one knew it was about to fall off a cliff, or that it would almost take the rest of the planet down with it when it did. According to the Journal, Bank of America's then-CEO Ken Lewis believed that the home-mortgage market was about to hit its low point and wanted to get in on the action while he still could.

Countrywide Financial was co-founded in 1969 by Angelo Mozilo, a take-no-prisoners entrepreneur who was also the company's CEO. By 1999, after 30 years of struggling to make a dent in the mortgage market, Countrywide had 7.3% of market share. By 2004, however, its share had jumped to 13.1%, making it the country's No. 1 mortgage originator.

Unfortunately for soon-to-be-owner Bank of America, much of that growth had been fueled by what turned out to be financial time bombs: subprime loans and adjustable-rate mortgages. Yet in 2007, Mozilo somehow managed to sell Bank of America a $2 billion position in Countrywide, and by July 2008 he had sold Bank of America the entire company.

Mozilo was convicted in 2010 of securities fraud and insider trading by the Securities and Exchange Commission. By the end of 2009, Lewis was gone from Bank of America, replaced by current CEO Brian Moynihan. At the time of the Countrywide purchase, Moynihan was Bank of America's investment banking chief.

We Broke It, You Bought It

"Obviously," Moynihan remarked in 2011, "there aren't many days when I get up and think positively about the Countrywide transaction." According to the Journal, Bank of America has spent most of the estimated $40 billion Countrywide cleanup cost on real-estate-related balance-sheet write-offs, funds set aside for toxic mortgage-backed securities claims, and legal costs relating to the Countrywide purchase.

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Bank of America now believes it has gotten a handle on the Countrywide issue, though it acknowledges it's holding out the possibility of another $5 billion in related losses. But is even that number to be believed?

Too Big to Understand

The superbanks, which also include JPMorgan Chase (JPM) and Citigroup (C), have balance sheets so vast and so complex, it's really anyone's guess as to whether the mountain of irresponsible lending in any of these institutions that led directly to the worst financial crisis in generations is even close to being cleared up.

JPMorgan had a $100 billion bet placed in the derivatives market that CEO Jamie Dimon didn't even know about until it started to go unmistakably south. He's still doing damage control on that one. Related losses were initially estimated to be $1 billion, but that quickly changed to $2 billion. Now, loss estimates range as high as $9 billion.

If Jamie Dimon, almost universally recognized as one of the best bank CEOs and risk managers in the business, can be so stupendously wrong when it comes to what's going on in his own bank, what about Brian Moynihan, then?

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How the Worst Deal in the History of Finance Could Get Even Worse

BOK (BOKF) is the smallest bank on the list with a $3.8 billion market value and $26 billion in assets. The bank holding company is based in Tulsa, Okla., but its branches operated under several names in other states: Bank of Albuquerque, Bank of Arizona, Bank of Arkansas, Bank of Kansas City, Bank of Oklahoma, Bank of Texas and Colorado State Bank and Trust. BOK is worth about 12.5 times earnings and is valued at 1.3 times book value. The return on equity is 11%, and it offers a 2.7% dividend yield to the common holders. Shares are trading around $56.00, and Wall Street analysts have a target above $59.00.

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Photo: Les Stockton, Flickr.com

KeyCorp (KEY) is the one exception in our list to our rule about share prices under $10. Its other metrics more than make up for this. It has a market cap of just $7.12 billion against some $87 billion in assets. It operates in 14 states throughout the Rocky Mountain, Northwest, the Great Lakes and Northeast regions. To make its appearance on this list even more impressive, KeyCorp is headquartered is in Cleveland, where a large number of now-troubled loans were issued. The bank has a return on equity of 9.2% and pays out a 2.7% dividend yield. Shares trade around $7.50 but have a target price of $9 from Wall Street.

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PNC (PNC) is based in Pittsburgh and has almost $300 billion in assets, with over 2,500 branches and almost 7,000 ATMs in 14 states. It has a market cap of $31.01 billion, and its stock is valued at 10.6 times earnings and at less than 0.9 times book value. The return on equity is 8.9%, and the company pays out a 2.73% dividend. Shares are trading at under $59, but Wall Street is eyeing a price of $70.50. PNC was even strong enough financially to close its National City acquisition at the end of 2008 when there was so much fear in the financial markets. PNC also owns almost a quarter of the great asset-management firm BlackRock (BLK).

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M&T Bank Corporation (MTB) is based in Buffalo, N.Y., and now has more than $79 billion in assets. Excluding any small purchases made recently, M&T had nearly 700 branches, 2,000 ATMs and a presence in eight states. The market cap is $10.12 billion, its P/E ratio is 12.7, and its price-to-book value ratio is only 1.07. M&T has a return on equity of 9.5% and pays out a dividend of 3.5% to common stockholders. The stock is trading just north of $80 a share, but analysts have set a target price of about $90. Berkshire Hathaway owns almost 5.4 million M&T Bank common shares worth more than $400 million.

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Photo: Afagen, Flickr

U.S. Bancorp (USB) is often overlooked as a money-center bank because it is a super-regional located in Minneapolis. But it's the fifth-largest commercial bank in the United States and caters to millions of consumers. With $341 billion in assets, more than 3,000 branch locations and more than 5,000 ATMs, its operations are spread out over 25 states in America. Berkshire Hathaway owns some 69 million shares worth more than $2.1 billion. The bank's market cap is $59 billion. It is worth about 10 times earnings and 1.6 times book value. The return on equity is very high at 16%, and it offers a 2.5% dividend yield to the common holders. Shares are trading around $31.50, and Wall Street analysts have a target of about $34.25 on this great, safe bank.

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Despite the media attention surrounding the JPMorgan's (JPM) multibillion-dollar trading loss, the firm is still in good shape compared to many of its peers. It has a fortress-like balance sheet with about $2.3 trillion in assets, and CEO Jamie Dimon has said the only thing that could lead to the bank's failure is a collision of the Earth and Moon. Despite a share price decline following news of the "London Whale" trading loss, the company still has a sizable market cap of $135.17 billion. Shares trade at less than 8 times earnings and only about 0.7 times book value. The return on equity is 9.8%, and the company pays a dividend yield of 3.4% on the common stock. While the bank shares are trading at just over $36, analysts value the company at $47 a share.

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Wells Fargo (WFC) is the undisputed safest bank in America now that JPMorgan Chase & Co. (JPM) has come under scrutiny -- even if Chase has about $1 trillion more in assets. With some 6,200 storefront branches, more than 12,000 ATMs and an asset base of over $1.3 trillion, it has a presence in almost every state. Warren Buffett's Berkshire Hathaway owns close to $13 billion worth of the common stock, and his stake keeps rising. The market cap is a whopping $171 billion. The shares trade at less than 9 times earnings and at almost 1.2 times book value. The return on equity is just above 12%, and it offers a 2.7% dividend yield to the common holders. While shares trade at around $32.50, Wall Street analysts value the bank at almost $38 per share.

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Gillian Tett, who writes on the banking sector for the Financial Times, and who authored one of the defining books on the financial crisis, Fool's Gold, recently wrote a column addressing bank size and complexity in relation to the botched JPMorgan trade. But it also applies nicely to Bank of America's current situation: "If you want a reason to break up the banks, you do not need to worry just about 'too big to fail'; the real danger today is that financial institutions and markets are becoming 'too big to understand.'"

That's how the worst deal in the history of finance could get even worse.



John Grgurich is a regular contributor to The Motley Fool, and holds no positions in any of the companies mentioned in this column. The Motley Fool owns shares of Bank of America, JPMorgan Chase, and Citigroup.
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