Will Bank of America Go Bust?

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Created on Thursday, 06 October 2011 14:22

Written by Sara Nunnally, Senior Research Director, Insiders Strategy Group

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Late yesterday, one of the greatest modern-day innovators passed away. Steve Jobs died Wednesday, one day after the latest version of the iPhone was announced.

His life was an amazing journey, and our world has been changed by his ideas and vision.

Jared has been following Jobs and Apple, and will have a full assessment on how his death will affect the company... and our world.

Our condolences to his family.

The banking industry is still having some image troubles, and it's not just because of the Occupy Wall Street protests that are gaining momentum.

Bank of America (BAC:NYSE) is in hot water. Its Countrywide division is accused of fraud for submitting faulty data in an audit. Half of the 14 loans reviewed by the Department of Housing and Urban Development (HUD) had big problems.

Here's the scam...

The bank issues an FHA mortgage to someone with less-than-stellar credit. That person defaults on the loan and the bank writes off the loss, getting reimbursed by the government because the FHA insures mortgages for borrowers who can't get a traditional loan.

HUD says banks didn't do their homework and pushed loans through without properly verifying things like the borrower's income and employment.

For Bank of America, it might have to pay $720,000 back to the government for the suspect loans the government has audited.

That's just the tip of the iceberg for BoA, though. It's deep in the red, and it could have to raise $50 billion just to deal with its mortgage issues.

This isn't the first instance of a bank lying to housing authorities.

Deutsche Bank AG (DB:NYSE) was sued for $1 billion because a subsidiary lied to the Federal Housing Authority about defunct loans.

Reuters reports that JPMorgan Chase (JPM:NYSE) and Wells Fargo (WFC:NYSE) could face some serious costs connected to FHA loans, too.

In all BoA, JPM and WFC could see $13.5 billion in costs.

It's a serious problem... FHA-insured loans account for 10% of all outstanding mortgage debt. That equals about $1 trillion, according to Paul Miller, analyst for FBR Capital Markets Corp. But the FHA only has $4.7 billion in its program.

That's less than half a percent!

To put it more bluntly, if only 1% of those FHA-insured mortgages go belly-up, the FHA program goes bankrupt.

No wonder HUD and the FHA are going after banks.

With the world starting to tip back into a recession, and bank failures still making the news, the housing market could get hit again. This would add insult to injury to the banks already in trouble. The FHA is going to ramp up its witch hunt.

You can bet that the FHA will try to pay out as little as possible.

This sentiment will be a giant weight on bank shares, but will be disproportionately heavy for BoA. While the market rallied yesterday, with the Dow closing up more than 1.2%, Bank of America was up a penny. That's a big difference from JPMorgan and Wells Fargo, who ended the day up 1.9% and 1.2% respectively.

If they're all going down, though, BoA will lead the way. That's the way things have been going lately. Take a look at this chart...

View larger chart

Over the past year, Bank of America has fallen more than twice as far as JPMorgan.

And get this... BoA's website has been nearly inaccessible for a week. The company says that this is because of a system upgrade and heavy traffic. Ironically, the interrupted service started right after the announcement that BoA customers will have to pay a $5 monthly fee for their debit card.

The company says the spotty Web connection wasn't because of hackers...

So, could Bank of America be hemorrhaging customers? Could the website interruptions be an attempt to preempt an electronic run on the bank?

Banks have shut down access to funds before. In Paris, at the start of the financial crisis, BNP Paribas halted withdraws from three investment funds because it couldn't value the assets it held. Turns out the funds were full of subprime mortgage-based securities.

Bear Sterns had done the same thing...

In London, Northern Rock's website kept crashing in mid-September just after it applied to the Bank of England for emergency liquidity funds.

As the sky started falling with the Lehman Brothers bankruptcy, people in the business were telling family members to go to an ATM and pull out cash because they weren't sure the banks were going to open on Monday.

I'm not saying this is what'll happen in the next day or week, but Bank of America has me worried. It's not Lehman, but it's not a small potato, either.

For sure, BoA will be at the bottom of the pile for the financial sector, and it might just drag the whole industry down with it.

Share prices could be headed toward the company's 2009 low of $3.14. BoA could at least match lows from back in December 1987 and November 1990.

Stay short for the whole financial sector, and ride Bank of America to the bottom.

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