Even though Warren Buffett once proclaimed that "turnarounds seldom turn," there's reason to believe that Bank of America will be able to propel its ailing operations into preeminence once again. I say that because it has done so before.
At multiple points throughout the 1980s, analysts and commentators believed Bank of America's days were numbered.
Continue Reading Below
Loan losses threatened to consume its capital and render it insolvent. A bloated expense base made high profitability all but impossible. And double-digit short-term interest rates fueled by soaring inflation led to billions of dollars in "mismatch" losses, as the bank's cost of funds exceeded the yield on many of its earning assets.
Making matters worse was the fact that Bank of America's customers started to worry about the safety of their deposits.
In 1983, Keefe, Bruyette & Woods, a firm that rates banks on a scale from "A" to "E," lowered Bank of America's rating from a "B/C" to a "C." If it was downgraded again, many corporations would be forced to pull their deposits from the California-based bank to protect against losing them in a failure.
One year later, KBW did just that, dropping Bank of America's rating from a "C" to a "C/D." KBW's lead bank analyst wrote at the time, "This latest announcement represents another setback which increases our concern about asset quality."
The news triggered a slow but steady decline in deposits. The nation's 10 largest money market funds dropped their deposits from $1 billion down to $300 million within three months of the announcement. And by the end of the first quarter of 1986, not a single one of the nation's biggest money market funds had money on deposit at Bank of America.
Large foreign corporations followed suit by shortening the maturity of their deposits from four to six months down to a matter of days. Even individual retirees responded to the news. "You'd see little gray-haired ladies come in. They'd withdraw their deposits and then you could literally watch them walk across the parking lot to the Security Pacific or Wells [Fargo] branch," said a retail banker quoted in Gary Hector's Breaking the Bank: The Decline of BankAmerica.
"It was not a panic; there was no run, no rush of depositors into branches to pull accounts," wrote Hector. "But a squeeze was occurring, just as it had at Continental Illinois," the nation's sixth-largest commercial bank prior to being seized by the FDIC in 1984.
Bank of America was teetering on the edge, and people knew it. Its situation was so perilous that Hector, a leading bank commentator, opined that it would likely be acquired by a competitor -- "probably in 1991 or shortly thereafter, when California law will permit banks outside the state to buy California banks" -- or be broken into pieces by federal regulators.
Yet, far from coming to fruition, these predictions soon turned out to be wholly inaccurate. After charging off billions of dollars in loan losses, selling tens of billions of dollars' worth of assets, reducing expenses, eliminating its dividend, and stacking its executive suite with former Wells Fargo executives, Bank of America was able to turn its operations around in time for the surge in economic activity during the 1990s.
In the five years between 1989 and 1993, Bank of America's average return on shareholders' equity was 16.3%, comfortably above the 12% to 14% range that even the best banks are able to achieve nowadays. And while its shareholders saw $3.3 billion worth of value evaporate from 1981 to 1987, this was more than made up for during the following decade.
My point is that the financial crisis of 2008-2009 isn't the first time Bank of America has faced adversity. While I've typically interpreted this as a sign that its culture is ill-suited for long-term success -- and, for the record, I still believe that's true -- it's worth noting that, if history is any guide, then the next couple of decades could nevertheless be incredibly profitable for the bank and its investors.
The article 1 Reason to Bet Big on Bank of America originally appeared on Fool.com.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Bank of America and Wells Fargo. The Motley Fool owns shares of Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.