Before closing the Countrywide deal, Bank of America (BAC) marked its assets to market–which resulted in a 15% cut in their value. Because of the huge leverage at Countrywide, this move nearly wiped out the firm’s book value.
If Countrywide had still been a publicly traded entity, it’s stock would now be all but worthless. And the same risk hangs over Washington Mutual (WM), Wachovia (WB), JP Morgan (JPM), and dozens of other banks.
It’s likely that Bank of America took more of a hatchet to Countrywide’s book than it had to: Might as well get all the bad news out of the way. It’s also likely that the drop in value of Countrywide’s assets is more pronounced than most banks’. But the Wall Street Journal runs the numbers on what would happen if some of the country’s bigger banks took smaller markdowns, and the results aren’t pretty:
[T]he reduction in the value of Countrywide’s loans raises the question of what would happen to other banks if they similarly marked loan portfolios to prices they could fetch if sold in the market today. Typically, banks create reserves equal to 1.5% to 3% of those portfolios, but the prices applied to Countrywide’s loans show those set-asides could be too low.
Applying a mark of 5% — more aggressive, but still well below Countrywide’s — at Citigroup, J.P. Morgan, Wells Fargo, Wachovia, Washington Mutual and Bank of America results in 10% to 30% reductions in the banks’ stated book values. Push the mark to 7.5% and book values are 20% to 50% below stated levels.
Even the 5% markdown would force many banks to raise more emergency capital, which would dilute current shareholders. Bigger markdowns would, in some cases, wipe them out. As the credit crisis spreads into prime mortgages, credit-cards, car loans, et al, markdowns of the magnitude described above are hardly farfetched.
Given the subjectivity involved in marking to market, moreover, it’s possible many banks are still overstating their assets’ value. There’s just no way for shareholders to know.
Last week’s trough, therefore, might indeed have been the “historic low” that many investors were celebrating after violent bounce in financial stocks earlier this week. Or it might just be another intermediate low.