Thursday, September 15, 2011

About BofA's Planned Restructuring

The business press and cable channels early this week were all abuzz with articles and segments about Brian Moynihan's plans to cut $5B of expenses and 30,000 net employees from the sluggish financial utility that BofA has become.

My take on Moynihan is aptly captured in these prior posts (here and here), with the second link containing a link to my piece written upon Moynihan's selection as BofA's CEO.

Interestingly, I noted in that last linked post, the one written in December of 2009, when Moynihan was named CEO of BofA, that he said he planned no significant strategic changes at the bank.

Well, it's nearly two years later, BofA is under legal attack for its Countrywide liabilities. Rather than hike the dividend or buy back shares, Moynihan did a generous deal with Warren Buffett to get $5B of additional preferred equity on terms no average investor would ever hope to receive.

And now he's planning on paring back the bank's massive consumer business, largely in response to Dodd-Frank's making those businesses- credit cards, debit cards, consumer lending, mortgages- structurally less profitable. Fair enough. The regulatory environment changed, so Moynihan is reacting, as Dick Bove contended, by retrenching in those areas hardest hit by the new laws.

But from an investment viewpoint, I see BofA as a toxic mess to be shunned for at least three years. Which is not to say that if you buy the bank's equity now, you might not see a big pop in 3-4 years. It's just that between the wait, and the risk of concentrating assets on a single troubled company, the return/risk may not be as rich as you think it will be.

My proprietary equity performance research found turnarounds of the type being attempted at BofA to be highly risky and usually a failure. Between the average total return gain and the chances of such a turnaround succeeding, the expected total return is far lower than investing in more stable, consistently-performing companies.

Then there's the nature of the sector and the bank. BofA has 288,000 employees and $27B in annual expenses, according to a Wall Street Journal article in Tuesday's edition. Thus, expenses are to be cut by 18%, and the net number of employees by almost 10%. But there's an unspecified churn in that employee number, as bank officials have said they'll fire more than 30,000, then hire some new people. That's going to be great for morale, huh?

You can imagine the amount of carnage that will begin to occur in focused businesses and locations. Chances are that expenses won't fall by the entire $5B, 30,000 employees will go, net, and revenues will fall further than Moynihan's optimistic planners expect.

These types of drastic downsizings tend to underestimate how the damage to morale throughout a large company will sap efforts to continue to just do business. Revenues in consumer businesses will likely decline by more than expected, and institutional revenues won't necessarily be immune, either.

Generally, firms which are cutting personnel and spending don't grow. Their total returns aren't typically attractive, either.

If BofA's cost- and personnel-cutting program was to spark a turnaround of some a sort that resulted in the company repositioning itself, exiting bad businesses, or entering promising new ones, there might be a chance that, a few years from now, the company would be an attractive investment.

But that's not the kind of restructuring that BofA is doing. Rather, it's trying to cut levels of spending on existing businesses, while shifting resources around among businesses it will largely still operate.

Worse, the same CEO who said two years ago he wasn't going to do anything substantially different, then said he'd push cross-selling, is putatively leading this effort. The first linked post I included above notes that Moynihan has no prior experience that would lead you to believe he has the slightest value to add to this project.

If BofA's board wanted to increase the chances of this effort making a difference for the company's shareholders, they should probably name Moynihan as a special counsel for mortgage-related legal matters, and replace him with a proven turnaround artist of the caliber of Robert Miller. But that's not going to happen.

Do you think that someone of Moynihan's limited banking experience, uneven corporate performance background, and generally legal-oriented skill set is the guy to oversee, let alone restructure, a company so complex as BofA, a modern global money-center bank?

I don't. It's Chuck Prince all over again.

And if Moynihan, by some miracle, succeeds in cutting expenses and headcount? What then? If you bought the stock now, took a lot of risk, you get a pop. Then it's back to your regularly-scheduled sleepy financial utility with little hope for breakout total return performances.

The truth is, banks of BofA's ilk- Chase, Citi, WellsFargo- are all pretty much similarly-organized and operated financial utilities. Aside from occasional timing plays, none are likely, for the foreseeable future, absent regulatory changes or serious breakups, to offer investors much hope of consistently superior total returns.

No comments: