Thursday, March 25, 2010

Bank of America Quick Comment: Principal Forgiveness a Net Positive $BAC [morgan stanley, Morning Star]

Morningstar Research

Bulls Say
  • B of A is a dominant player in some of the most dynamic, high-growth regions in the country, such as
  • California, Florida, and Texas. The sunshine that helped attract growth in the early part of the decade is still shining, and should help reignite growth after the recession wanes.
  • The bank has an immense deposit base of $975 billion, giving it a stable, low-cost source of funding.
  • Only 10% of B of A's estimated 8 million affluent customers currently use its wealth-management products. B of A could rapidly increase fees in this division just by attracting more of its checking account customers.
  • Merrill Lynch has the premier wealth-management business in the nation, with more than 16,000 advisors. This wide-moat business is its crown jewel.

Bears Say
  • The addition of Merrill significantly alters B of A's revenue and earnings structure. We're not big fans of investment banking right now, and we worry that the downside of the investment banking business could more than offset the benefit of the wealth-management business.
  • Although the bank's trading operations were very profitable in the past, the credit crunch wiped out the investment bank's earnings in 2007 and 2008. With the securities markets recovering, we expect loan charge-offs to drive losses in 2009 and much of 2010.
  • We believe the credit crisis will compel the government to increase capital requirements for all banks. As one of the top four, we expect the government to add something extra to B of A's capital burden to

B of A Opts Out of Opt In

Morgan Stanley Research

Impact on our views: We view BAC’s enhancements to its NHRP, including principal forgiveness on severely underwater loans (120%+ LTV), as an incremental positive for the firm as it incentivizes homeowners to continue payments. While BAC may write down principal on the eligible pool by as much as 15-20%, it has reserved for this and these moves should help the firm generate positive cash flows that it might not have received otherwise. We believe BAC’s estimated $3b of principal reductions over 5 years is immaterial to balance sheet/EPS, as just 15-20% of the ~$10b eligible pool (roughly $1.5-$2b) of Pay-Option ARMs, subprime, and prime 2-year hybrid ARMs are carried on balance sheet. We bake in a further decline of home prices from current levels (currently down 33% vs peak, we expect to bottom around 37-40% down vs peak). If BAC’s approach is broadly accepted by the marketplace, it could reduce the number of foreclosures and yield a less severe than expected impact on housing prices.

What's new: BAC announced it will introduce earned principal forgiveness and other enhancements to its “National Homeownership Retention Program” (NHRP). The new components include: 1) principal forgiveness/ reductions on qualifying mortgages that are 60+ days delinquent with an LTV of 120%+; 2) reducing negative amortization on certain Pay-Option ARMs and converting some Pay-Option ARMs to fully amortizing loans; and 3) addition of certain prime 2-yr hybrid ARMs and Countrywide mortgages originated on/before 1/1/09 as eligible for the NHRP. Link to press release:

Principal Forgiveness a Net Positive

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