It would be easy to miss the most important lesson from Bank of America Corp.'s goodwill charge on its card portfolio — or take away the wrong one.
The $20 billion hit was big, out of the blue and involved a crucial consumer business. It seemed to suggest an already troubled unit was taking a turn for the worse.
Yet a closer examination shows it was less a foreshadowing of further credit problems, and more a warning of the risks of weak financial controls and a reminder of the legacy businesses that still haunt B of A.
Fortunately for the company, this particular charge didn't hurt consolidated financial results. But other acquisition-related issues (read Countrywide) may, and that makes analysts nervous.
The writedown "just reinforces investors' general uncertainty about regulatory compliance issues and accounting issues associated with some of their past acquisitions," said Claude Hanley, a partner at the financial services consulting firm Capital Performance Group.
B of A, of Charlotte, N.C., last week restated results covering the eight quarters of 2009 and 2010 for the legal entity that contains its credit card operations, known as FIA Card Services, in its call reports. The bank said it determined it needed to record a goodwill impairment that was double what it had previously declared.
The credit card business had shown gradual improvement, but the announcement had many in the market questioning whether that had been real.
Since then, however, analysts have downplayed those fears and insist that credit metrics are indeed getting better. But the charge is indicative of other, less-publicized problems B of A has been working to fix: Its internal controls.
"It's not that the internal performance of the credit card portfolio is performing worse," said Paul Miller, an analyst at FBR Capital Markets. "I think what it really shows is the confusion of management."
Curt Beaudouin, senior analyst at Moody's Investors Service, said the writedown "did highlight some weakness in internal financial controls at the company, particularly at the legal entity level. But ultimately the company is taking steps to address that, and I think that's an important mitigant in this case."
B of A insists that, if anything, the restatement is a sign that its internal controls are improving.
"We're much more focused on much more detail today than we were before the crisis in certain areas," B of A spokesman Bob Stickler said. "That I think accounts for why we caught this. … What you would say today is that we have better controls."
How B of A arrived at the $20.3 billion goodwill impairment has caused a lot of head-scratching. Essentially, it boils down to the company's realization that it overpaid for some big acquisitions in its FIA unit, namely that of the credit card giant MBNA Corp. in early 2006, based on how the business has since performed.
B of A periodically tests the carrying value of the goodwill of each of its business segments. Goodwill is an asset recorded on a business' balance sheet to reflect the value of such intangible things as brand, proprietary technology and patents.
But in early 2009, B of A was preoccupied with its acquisition of Merrill Lynch & Co., among other things. It failed to test the goodwill at the legal entity level, or of FIA specifically, but ran a test on the overall business segment of which FIA is a part, its global card services division. At the time, it determined it did not need to take an impairment charge.
In early 2010, B of A conducted a test and found that it needed to take a $10.4 billion goodwill impairment for FIA because of the economic downturn and detrimental regulatory reforms. Then, in late 2010, B of A went back and ran an impairment test on FIA for the first quarter of 2009. That's when it realized it should have taken a $20.3 billion goodwill impairment charge, based on the deteriorating credit quality of the portfolio at the time. Once B of A accounted for that writedown, it could reverse the earlier $10.4 billion writedown, because that was reflected in the $20.3 billion impairment.
The charge only affected the net income of the FIA subsidiary, not the net income of the entire company on a consolidated basis that it reports to the Securities and Exchange Commission. This is because the global card services division also includes B of A's debit card business, which held up exceptionally well throughout the downturn as more consumers moved to using money already in their checking accounts instead of taking on more debt. The debit business offset the losses in the credit card unit under accounting treatments used in SEC filings.
(Adding to the mix, B of A took a completely separate $10.4 billion charge in the third quarter of 2010 related to its global card services unit, mainly because of the impact of the Durbin rule, part of the Dodd-Frank Act that capped debit interchange fees.)
"We paid a premium for MBNA," Stickler acknowledged. "Conditions changed dramatically. You had a very severe recession, which caused our credit card losses to soar into the double digits and at the same time you had the CARD Act, which would affect your future revenues and in effect it meant the value of the business was less than it was before."
It's a situation that is fairly unique to B of A, as the other major credit card issuers either developed their own card businesses organically, or made acquisitions so long ago that the same changes in goodwill don't apply, Stickler said.
But he was upbeat on the future prospects of the card business.
"Today the economy is better; the card business is better," Stickler said. "This says nothing about the future."
Analysts agree that, ultimately, the writedown is not an indication of potential minefields in the credit card portfolio.
"They are basically saying, 'We would not have overpaid this much if we knew they were going to change the rules on us,' " Miller said.
Hanley agreed saying, "All you can … factually glean from this announcement is the price that they paid a number of years ago when they acquired those businesses now looks high given the dynamics in the business."
B of A's chargeoff and delinquency rates in its credit card portfolio have consistently been higher than those of its peers Citigroup Inc. and JPMorgan Chase & Co.
Still, B of A's global card services unit released $7 billion of reserves in 2010, compared with an increase in reserves of $3.4 billion in 2009, a surefire sign that the bank is seeing an improvement, said Whitney Young, an analyst at Raymond James.
"A goodwill impairment charge isn't a positive thing, but it's backward looking," she said. "The important thing to focus on is that for over a year they have been releasing reserves primarily because of credit cards. If things were getting worse, we wouldn't see that."
Managed net credit card losses at B of A peaked in the third quarter of 2009, with the bank charging off $5.5 billion, or 12.9% of all credit card loans.
Losses have wavered since then, picking up slightly in the first and second quarters of last year. In the fourth quarter of 2010, the chargeoff rate totaled 8.24%, the lowest since the fourth quarter of 2008, the peak of the financial crisis.
The bigger concern, analysts said, is how acquisitions in the mortgage unit — such as the purchase in 2008 of subprime lender Countrywide Financial Corp. — could come back to bite B of A.
"A lot of their mortgage issues are tied into their acquisition of Countrywide," Hanley said.
"I'd be less concerned about the writedown on this card portfolio than I am on their exposure to the mortgage foreclosure issues because there you don't really know what the dollar amount will be," he said.