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A fateful step for a banking giant

By Steven Mufson
Washington Post Staff Writer
Sunday, December 5, 2010; G01

When Bank of America agreed to buy Countrywide Financial for $4 billion in January 2008, the bank's chief executive, Kenneth D. Lewis, called it a "one-time opportunity."

When this opportunity knocked, however, it blew the door down. More than two years after the acquisition, Bank of America has taken write-offs of $5.5 billion because of troubles at Countrywide. And the losses are still mounting.

Now, instead of celebrating its improved profits and stronger capital base, the bank is trapped in a "Groundhog Day"-style routine of fending off crisis.

Bank of America has set aside billions of dollars more to clean up Countrywide's mortgage mess, including an avalanche of new disputes about faulty paperwork and foreclosures - and some analysts say it won't be enough. It has thrown 20,000 employees - the equivalent of two Army divisions - at the job of dealing with the delinquent mortgages. Most of those are the legacy of Countrywide, which originated 10 million of the 14 million loans Bank of America is managing.

That legacy is a burden not only for Bank of America but also for the entire country. Countrywide's bad mortgages are clogging the U.S. housing market, dragging down home values and slowing the recovery.

Moreover, the Countrywide mess has tarnished Bank of America's reputation and put it back at the feet of the government not a year after it repaid its $45 billion federal bailout with interest. No bailout is needed this time, but federal agencies - as regulators and holders of vast amounts of mortgage securities - can either ease or ratchet up pressure on the bank to find a solution.

For the foreseeable future, the morass at Countrywide has also put an end to the freewheeling acquisition strategy that made the Charlotte-based bank the biggest in the United States.

"Countrywide was a garbage bin," said Richard X. Bove, a banking analyst with Rochdale Securities. "All they did was make loans they could to whomever they could at whatever rate they could. If Bank of America hadn't made this acquisition, they would have problems, but nothing remotely close to what they have now."

"I think they're just going to rue the day they bought Countrywide," said the chief strategist of a major asset management firm who spoke on the condition of anonymity. "That was just a train wreck."

To Bank of America executives, however, Countrywide was a good investment that will pay off, albeit more slowly than expected. The acquisition satisfied two key goals, according to Barbara J. Desoer, president of Bank of America's home loan unit. It boosted the bank's share of the U.S. mortgage market and expanded its offerings for customers. Building that business from within would have been time-consuming and expensive.

"For our customer base, their needs were broader than what we had to deliver," Desoer said in a conference room in the Willard tower, half a block from the Treasury. "We had a gap. Countrywide was an opportunity . . . to close that gap by acquiring a large retail network."

The purchase catapulted Bank of America from a distant sixth place to No. 1 in mortgage originations.

There were two problems with that. First, the bank expanded into mortgages just as the housing market and economy began to crumble. Second, Countrywide was built on a different corporate culture - and looser lending practices. Its book of mortgages was swollen with subprime loans, those that required no evidence of income and gimmicks that encouraged people to borrow more than they could afford.

Lewis, who stepped down in late 2009, said he knew he was getting a distressed price for Countrywide, but later it appeared that he hadn't realized just how distressed Countrywide was. About 15 percent of the borrowers inherited from Countrywide are behind on payments, compared with 6 percent for loans originated by Bank of America.

Desoer, once seen as a potential successor to Lewis, conceded that, in addition to losses, there have been "reputational costs associated" with the Countrywide purchase. She should know - each week, usually on Fridays, she listens to recordings of phone calls that customers have made to service representatives.

But, she says, Bank of America is weeding out the subprime mortgages; it has modified 725,000 mortgages since January 2008. More than 1 million customers are still struggling to make loan payments.

"I'm not a believer in the subprime business, and we have at Bank of America and all the legacy companies shut it down over and over and over again," Brian Moynihan, the bank's chief executive, said Nov. 4 at the BancAnalysts Association of Boston Conference. "We will not be in that business."

Shutting it down isn't easy, though. The discovery of shoddy paperwork forced Bank of America in October to halt 102,000 foreclosures in 27 states, pending the filing of new paperwork generated from a new process. After declaring a nationwide moratorium on foreclosures Oct. 18, Bank of America did a quick review - too quick, some critics said - and restarted the filing of affidavits needed for foreclosures in 23 other states.

State attorneys general and housing advocates aren't satisfied with the bank's assurances about new procedures.

"It's not that other banks are so great, but Bank of America is particularly striking in its inability to just give us the most basic information about what's going on," said Lisa Sitkin, a lawyer with Housing and Economic Rights Advocates, an Oakland, Calif.-based nonprofit organization. "It often seems like a sort of black hole of information."

Sitkin said that when the bank modifies loans under a government program, the process is slow but the standards are clear. But when Bank of America proposes its own modification terms to borrowers, the method is opaque. For those cases, which account for 88 percent of its modifications, the bank has a confidential "foreclosure avoidance budget" that weighs the value of a modified loan against a foreclosed one.

Bank of America agents working on delinquent loans are "nice enough," Sitkin said. "They've sort of gotten better, but that's only because they were so bad. Now they're just bad, I guess."

"It's a day-to-day hand-to-hand combat," Moynihan said, answering a question about the Countrywide backlog after a recent speech. "In end of the day, we'll work through it." He added, "It's in everybody's interest to get this settled and behind us."

Too big?

Despite the hassles, Desoer said, Bank of America likes Countrywide's size and the reach that comes with it. Bank of America's share of the mortgage origination market has gone from single digits to just over 20 percent - although the mortgage market this year is barely half the size it was in 2007. It alternates between No. 1 and 2 in loan production with Wells Fargo.

Bank of America executives now boast that they do business with one of every two U.S. households and can provide whatever those customers need. Moynihan also highlighted the bank's international scope, mentioning business in Vietnam.

Not everyone sees that size as a virtue. "At some point, an institution that is too big to fail is also too big to manage and too big to regulate," said one federal official who spoke on the condition of anonymity because he is not authorized to speak for the Obama administration. "It's just beyond human capacity."

Nationwide dominance was the goal of the bank's two corporate parents. Its namesake was built by A.P. Giannini, who founded a bank in 1904 to help Italian immigrants who were denied service by other banks. He wanted a nationwide bank but was largely confined by regulators to California.

The other parent was Nations Bank, built by the ravenous Hugh McColl. He turned a regional bank into a super-regional and then national one by closing 100 deals in eight years, swallowing institutions such as the bankrupt First Republic Bank. At the time, McColl's purchase of Bank of America in 1998 was the biggest bank acquisition in history.

The new behemoth gobbled up rivals. In 2001, it paid $47 billion for FleetBoston Financial. In 2005, it announced the $35 billion acquisition of credit card giant MBNA. In 2007, it bought LaSalle Bank for $21 billion.

"McColl had a crystal hand grenade on his desk," said Karen Petrou, a banking industry analyst. McColl, who urged employees to shake up the business, gave the trophies as performance awards. "The bank was built on takeovers, and it was always the next deal that got you out of the last one. It was a beat-the-reaper M&A culture."

So when Bank of America bought Countrywide, it seemed a natural, albeit somewhat risky, extension of the bank's strategy.

Some financiers smelled trouble. Countrywide's flashy Bronx-born chief executive, Angelo Mozilo, had quickly expanded the company - perhaps too quickly.

In early 2007, Lewis Sanders, then the chief executive of Alliance Bernstein, asked his top lieutenants what they thought of Countrywide. Alliance was one of its largest shareholders. The group cited pluses and minuses. But when Sanders couldn't get Countrywide's chief executive on the phone, he grew suspicious. He traveled across the country to see him in person, but Mozilo refused to meet him. Sanders flew home and sold his firm's entire position.

As 2007 progressed, Countrywide's woes became clearer. By December, its loan delinquency rate climbed to 7.2 percent, up from 4.6 percent a year earlier. Investors were demanding that it buy back bad loans it had sold them as part of packages with thousands of mortgages.

Enter Bank of America.

"We recognized that we were buying a company with a lot of troubles," said one senior bank executive who spoke on the condition of anonymity. "We got rid of the leadership. We got rid of a lot of the activities that got them into trouble."

He added, "We're cleaning up, but it's a big clean-up."

Bigger than expected. The bank now has 1.3 million customers who are more than 60 days delinquent; 195,000 haven't paid in two years. Of those homes, 56,000 are vacant.

The size of the problem is staggering, especially because only five firms manage the bulk of the country's mortgages, which have been bundled in packages and sold off to investors.

Moynihan said that all originations from 2004 to 2008 totaled about $1.2 trillion. He said investors have demanded that Bank of America repurchase $18 billion, alleging that the bank had misled them. Of those, $11.4 billion have been resolved, with losses totaling $2.5 billion.

About $6.6 billion of claims remain under review, Moynihan said, although analysts say more could be coming. Moynihan cautioned that a claim does not necessarily result in a repurchase. Even if the bank repurchases a loan, it doesn't mean it loses the entire unpaid principal amount of the loan.

"We will learn our lessons here and make sure that we protect ourselves," Moynihan said.

One other unexpected cost this year: In October, Bank of America paid $43.5 million of the $67.5 million settlement Mozilo reached with the Securities and Exchange Commission over charges that he committed fraud and insider trading while concealing from investors what the SEC called "a looming disaster."

Even if Bank of America ultimately gets through the mortgage mess, the episode has damaged its relationships with big investors, including federal agencies, which bought the bulk of those mortgages.

A group of investors - including the Federal Reserve Bank of New York, the government-owned Fannie Mae and Freddie Mac housing finance firms, pension funds, and the big investment firms Pimco and BlackRock - sent a letter threatening to force the bank to repurchase the mortgage packages by late December. The group accuses Bank of America of renegotiating mortgages owned by investors, while avoiding a hit on the home equity or credit card debt owed directly to the bank.

Moynihan said the letter "was a surprise to me, and I think it was a surprise to a lot of people, quite frankly."

Blame the economy?

Many Bank of America executives blame the economic slump for aggravating Countrywide's problems, but the bank gets little sympathy from the public or lawmakers.

"Over the course of the crisis, we as an industry caused a lot of damage," Moynihan acknowledged in January testimony before the Financial Crisis Inquiry Commission. "And it has been clear how poor business judgments we have made have affected Main Street."

Now the bank says it has changed its strategy.

"We are not making any acquisitions," Moynihan said at the Nov. 4 financial conference.

Instead the bank says it wants to nurture its relationships with customers, not acquire new ones. It wants to please consumer advocates, too; it no longer lets people take overdrafts with ATM cards, even though it used to collect hefty fees when they did so.

That's not just an outburst of affection for customers. Petrou, the analyst, noted that it's "because of the limits on owning more than 10 percent of deposits [nationwide]. They can't do any acquisitions anyway." Thanks to exceptions for buying failed savings and loan institutions, Petrou said, the bank's share of national deposits is slightly above 10 percent.

Regulation will also shape Bank of America's new era. Under the recently tightened international standards adopted in Basel, Switzerland, it must raise capital reserves. And under the new U.S. financial regulatory law, it can no longer charge certain types of fees for credit card use. In the third quarter, Bank of America took a $10 billion write-off for its credit card division, citing the future loss of earnings from activities the new legislation declared off-limits. (The bank currently earns 10.72 percent on nearly $120 billion of U.S. credit card debt.)

Among the few bright spots is the global markets and banking unit, which, bolstered by the 2009 acquisition of Merrill Lynch, made $5.6 billion in the first nine months of this year.

With the slow recovery, however, the bank's mortgage problems won't go away soon.

"With the high unemployment and the nature of the economic crisis," Desoer said, "the number of borrowers in default is going to be with us for a while."

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