America just can’t catch a break. Just when you think we’ve had a single day with no economic bad news, the next story breaks. Today’s latest bombshell is that Bank of America will be cutting around 30,000 jobs, which constitutes about 10% of its workforce. How did this happen? Let’s delve into B of A’s recent history, and see if the job cuts are really a surprising development.
Housing Boom and Bigger is Better
As the housing boom was peaking, Bank of America seemed to be following the age-old American strategy of bigger is better. Like many of the big banks, B of A continued to snap up smaller companies to diversify its offerings. In 2006 Bank of America acquired MBNA for about $35 billion. MBNA, one of the world’s biggest independent credit card issuer, would help diversify Bank of America’s card services business.
Other acquisitions would follow most notably Countrywide for about $4 billion in January 2008 and Merrill Lynch for about $50 billion in the fall of 2008. Although these acquisitions seemed to provide for both growth opportunities and diversification, they have not done so. In reality, the losses stemming from these acquisitions have dragged Bank of America’s earnings and stock price down for the past three years.
In Comes Moynihan – January 2010
In January of 2010 Brian Moynihan came to the helm of Bank of America as CEO. Moynihan was an inside hire, having been with B of A since 2004. With the change in command, Bank of America could now begin in earnest to brace itself for the mortgage losses that were sure to continue in the quarters and years ahead.
Foreclosure Problems, Upset Investors, Lawsuits
Brady Dennis of the Washington Post summed up the issues B of A has been facing in the past year. B of A “faces a barrage of lawsuits by investors who plowed money into packages of loans that turned out to be worth far less than anticipated.” What is the cost to settle these lawsuits? A cool $8.5 billion.
Next, AIG filed a separate lawsuit for over $10 billion on similar grounds. Finally, the Federal Housing Finance Agency (FHFA) filed a lawsuit saying the mortgage investments sold to both Fannie Mae and Freddie Mac were fraudulent.
Wait, there’s more. Dennis notes that “Bank of America and a handful of other large firms are mired in settlement talks with state attorneys general over shoddy foreclosure practices that came to light last fall. Among other elements, the banks involved could wind up paying $20 billion in penalties for their actions, with Bank of America footing a sizable chunk of that amount.”
Buffett’s Investment Helps, Workforce Cuts Help Too
Viewing B of A’s struggles all together, it is no surprise that Moynihan and the Board elected to accept Buffett’s investment offer of $5 billion. Although his warrants were quickly in the money, clearly there is a long road ahead and the capital from Buffett would help offset continued mortgage losses. After all, the 2nd quarter for Bank of America was dreadful: an $8.8 billion loss.
This brings us back to job cuts. Buffett’s investment was a one-time cash infusion. Moynihan is clearly looking for recurring savings to help right-size Bank of America. Of the estimated $27 billion in operating expenses B of A incurs annually in consumer and small banking, Moynihan wants to cut $5 billion. These cuts, although painful in light of America’s job situation, might go a long way to restore investor confidence in and profitability to Bank of America.