Ken Lewis Says BofA Is Fine. Do We Buy It?

Updated from Tuesday, March 3

CEO Ken Lewis says Bank of America ( BAC) is strong and doesn't need more government assistance. The market says BofA is worth nearly 90% less today than it was a year ago.

Are these two sentiments reconcilable?

Lewis, the bank's CEO, asserted before Congress last month that BofA's "core business is strong." He told staffers in a memo last month that, "Bank of America does not need any further assistance today, and I am confident we will not need any further assistance in the future. I believe our company has more than enough capital, liquidity and earnings power to make it through this downturn on our own from here on out."

He went a step further on Monday, telling the Financial Times that BofA accepted too much money from the government. Lewis called his request for $20 billion to support the bank's acquisition of Merrill Lynch a "tactical mistake" that was done out of "an abundance of caution." Bank of America only needed half that amount, he told the FT.

Investors have heard Lewis' line before -- from executives at Lehman Brothers, Citigroup ( C), AIG ( AIG), Fannie Mae ( FNM) and Freddie Mac ( FRE), among others -- and are loathe to trust the CEOs of financial institutions on their word alone.

Citi needed another massive lifeline from the government last week, and rumors circulated that BofA -- another banking behemoth with a myriad of financial services products -- would be the next to fall.

Worries persist, especially in light of Bank of America's substantial risk exposure in several categories: Credit cards, mortgages and investment banking.

BofA acquired MBNA for $35 billion in 2005, creating one of the largest credit-card issuers in the world. But now that strained consumers are relying more heavily on plastic to finance their lives amid layoffs, pay cuts and declining household wealth, analysts and economists have speculated that credit cards may be the next shoe to drop in terms of toxic debt.

Last July, BofA snapped up Countrywide Financial, the country's largest mortgage lender and servicer, in an all-stock, as it teetered on the brink of collapse. The deal seemed like a bargain at the time, despite Countrywide's heavy exposure to subprime mortgages. But now the economy has worsened and defaults have spread to less and less risky housing debt, bringing up questions about BofA's exposure.

Then came the ill-fated Merrill deal.

Months after the Countrywide acquisition closed, the financial markets spun into deeper turmoil, with Lehman filing for bankruptcy in September, followed days later by emergency bailouts of Fannie, Freddie and AIG. Counterparties and investors sensed guilt by association, punishing other Wall Street firms, especially Merrill Lynch, whose heavy exposure to subprime mortgage securities threatened the firm's solvency.

Lewis smelled a bargain and bought Merrill in an all-stock deal, in an effort to beef up BofA's brokerage and investment banking operations. But losses escalated from Merrill's troubled assets and Bank of America considered walking away from the deal. It sought additional funds from the government instead, leading investors to question the due diligence Lewis performed before inking the Merrill deal, and creating more uncertainty about what troubles lay ahead for BofA.

Lewis' recent declarations are clearly an effort to wipe away some of the negative attention Bank of America has received for the deal, and bolster confidence in the firm's financial health. That's not to say he is misleading the public about BofA's financial standing -- which would be illegal -- but that his carefully-worded statements are not guarantees.

"These are officers of public companies and they're fully aware of their responsibility when it comes to misinformation," says Leo Tilman, former chief strategist at Bear Stearns and BlackRock ( BLK) and author of the book Financial Darwinism. "Therefore I have no reason to believe that any of these statements are purposefully misleading."

However, he continues, "in the case of BofA and Merrill, and in the case of Wachovia and Golden West and other things, there was a disconnect between executive decisions and risk management. The rationale was business rationale -- synergies between business lines and market share -- but the risks were discovered later on."

Past performance is no guarantee of future success, and Lewis may well trump competitors to shepherd Bank of America back to pristine financial condition managing risk appropriately, paying off government debt and boosting profitability. The Mississippi native has been in charge of BofA since 2001, expanding its business while limiting exposure to subprime woes that crippled competitors.

Jim McDavid worked with Lewis, as well as his predecessor Hugh McColl, years ago at North Carolina National Bank, which eventually became Bank of America through a series of acquisitions. He characterizes Lewis as an honest, "cautious kind of guy" who is "laid back and reserved," especially in comparison to McColl who was more of a firebrand.

Still, the 72-year-old McDavid sold the family's preferred stock in Bank of America last week -- not because of doubts about Lewis' leadership, but because of uncertainty about what would happen to the company in light of the government's unprecedented intervention. He characterizes the transaction with tones of regret and guilt.

"It began to look like this thing was going sour again -- especially with AIG -- and you couldn't get any straight answers out of anybody," says McDavid. "It's the first time I ever thought the thing to do was 100% liquidation ... But I could not sit there and just watch the value sift by hour after hour."

McDavid is certainly not alone in his sentiments, as investors have fled financial stocks en masse. BofA may not be a penny stock, but its market value has plunged from $183.1 billion at the end of 2007 to a mere $18.01 billion at Wednesday's market close, when it finished trading down 1.4% to $3.59.

That deterioration can be blamed on anything from the recession to broad market turmoil to uncertainty about Bank of America's assets to its latest emergency loan. Maybe Bank of America is truly undervalued, as a report from Buckingham Research indicated on Monday, advising clients to accumulate shares.

"We emphasize Bank of America is not Citigroup," says analyst James Mitchell.

But retail investors may be wise to heed Peter Sorrentino, senior portfolio manager of Huntington Asset Advisors. He's been meeting with retail clients on a daily basis, advising them to avoid stocks like Bank of America, at least until "they get the government monkey off their back."

He also notes that banks are difficult to value, with unknown quantities of unknown assets at unknown prices on their books. Furthermore, the economic recovery that could help stem defaults and boost banks' business is far from evident today. All of those concerns led S&P to downgrade ratings on Bank of America debt on Tuesday.

"There will be a huge snapback rally in financials at some point," says Sorrentino "but that might be far down the road."

Or, as Roger Young, portfolio manager of Miller/Howard Investments, puts it: "Bank of America is at $3.75 today. It might be a better buy at $5 than it is at $3.75."