1 Big Surprise about B of A


The conventional wisdom is that Bank of America has two problems. First, it's exposed to massive legal liability dating back to the financial crisis. And second, that it still has tens of billions of dollars in losses to absorb from the bad mortgages on its balance sheet.

While the first problem is indeed a concern, as I discussed at length in this recent series, it turns out that the second issue is, as Jamie Dimon might put it, a "tempest in a teapot." Believe it or not, out of the nearly $250 billion in mortgages on B of A's balance sheet, it appears to face only $1.4 billion in losses. Not only is that an extremely digestible number, but it stands in direct contrast to any type of negative opinion of B of A's balance sheet -- at least as far as toxic mortgages are concerned.

To arrive at this number, let's start at the top. B of A's balance sheet contains $2.17 trillion in assets, making it the nation's second largest bank behind only JPMorgan Chase. Loans and leases account for $893 billion of the total, $561 billion of which are consumer loans, and $247 billion relate to residential mortgages specifically. So that's our jumping off point: $247 billion.

It's now necessary to dig into the quality of these loans. There's two somewhat equivalent ways to do this. The first and more arduous way is to work through B of A's delinquent mortgages. At the end of the third quarter, it reported a total of $40.9 billion in loans that are late on payment, the majority of which are more than 90 days past due, a critical benchmark in the banking industry. Of these, however, $25.1 billion are fully insured by either Fannie Mae, Freddie Mac, or the FHA. That leaves only $15.8 billion in uninsured delinquent mortgages that, at least at this point, appear to threaten B of A's capital base.

The second and easier way to arrive at an estimate of the latter figure is to take B of A's own disclosure of nonperforming loans -- for the most part, these are loans that are no longer automatically accruing interest. At the end of the third quarter, the value of mortgages classified as such came in at $15.2 billion. This is only $600 million less than the total amount of uninsured delinquent mortgages from the end of the preceding paragraph.

At first glance, then, it appears that B of A is on the hook for a lot more than the $1.4 billion that I quoted at the beginning of this article. But here's where it gets interesting. Once a mortgage has been delinquent for more than 180 days, B of A charges it off -- or at least the portion of the loan that it expects to lose.

For example, say the bank holds a $200,000 mortgage secured by property that's worth $125,000. If that loan goes unpaid for more than 180 days, B of A charges off the difference between the mortgage amount and the collateral's value less foreclosure costs. Assuming the latter costs are $35,000, between paying a lawyer and getting it in condition to sell, B of A would accordingly record a $110,000 loss on it, or 55% of the mortgage's outstanding value - as a side note, this is the "severity rate" that B of A uses for toxic mortgages it's forced to repurchase from institutional investors.

To get back to the main point, then, a full $9.5 billion of B of A's $15.2 billion in nonperforming mortgages are more than 180 days past due, meaning the bank has already taken the loss of them. That leaves us with $5.7 billion in nonperforming loans that haven't already been charged off. And to add one final twist, according to B of A, $3.1 billion of these are actually still being paid by the borrowers -- they're classified as nonaccrual, and thus nonperforming, simply for regulatory reasons. Once you remove this final chunk, in turn, we get $2.6 billion in mortgages that are noncurrent, nonperforming, and not already charged off. After applying the 55% loss severity rate quoted above, we get ... drum roll ... $1.4 billion.

So there you have it. While B of A has plenty of problems, as I covered in detail in this series, one of them is not a mountain of owned mortgages on its balance sheet.

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