Small Business Emerges as Trouble Spot for Bank of America

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Bank of America Corp. said credit deterioration is beginning to spread beyond its consumer operations into areas such as small-business lending.

Joe Price, the $1.72 trillion-asset Charlotte company's chief financial officer, said during a conference call Tuesday to discuss its weak fourth-quarter earnings that the company is taking actions to curb the rise of problematic small-business loans. Net chargeoffs in that area jumped 17% from the third quarter and 141% from a year earlier, to $277 million. At 6.33%, the loss rate there was higher than even that of B of A's credit card portfolio.

Nonperforming small-business assets rose 39% from the third quarter and 71% from a year earlier, to $135 million. B of A joined Wells Fargo & Co. in San Francisco this earnings season in reporting deteriorating credit quality among small-business clients. Like Wells, which reported last week, B of A cited business credit cards. Mr. Price said its issues stem largely from business card accounts opened in 2005 and 2006, though his company has taken several steps to address the issues, including offering smaller credit lines, changing direct mail offers, and using more judgmental lending techniques. As a result, credit scores are on the rise, and there has been "a meaningful drop in approval rates."

In an interview after the call, Mr. Price also said that other "consumer-dependent" areas are expected to have deteriorating credit quality this year, with retailers being the most likely victims. Though he did not take an alarmist tone, he said that credit deterioration "could be a little broader" than just in consumer areas.

Credit quality will play a key role in B of A's efforts to meet its full-year earnings guidance. Those efforts also will rely heavily on avoiding another capital markets lockdown and a prolonged recession. However, the company commented very little on its plans to buy Countrywide Financial Corp. in Calabasas, Calif., beyond saying that it expects the deal to be operationally neutral to earnings this year.

"Nothing has changed" since B of A announced the $4 billion deal this month, Mr. Price said during the interview. However, he also said buying Countrywide would affect earnings when it comes to raising the capital needed to support the acquisition and return Tier 1 capital to his company's 8% target. B of A is looking into a preferred stock offering, he said, perhaps with a convertible element, though that could knock about 10 cents a share off its full-year earnings; that has been factored into its guidance.

Kenneth D. Lewis, B of A's chairman, president, and chief executive, told analysts during the earnings conference call that he expects his company to report earnings "well above" $4 a share for this year. He also said that such a mark would be achievable "absent a market disruption event like we experienced in 2007." As the call continued, there were more stipulations to the forecast. Mr. Lewis said the guidance takes into account expectations of "very modest growth — virtually none — in the first half of the year" in the U.S. economy before a return to 2% growth at yearend. In response to a question, he said that the projections could withstand a "mild, short-lived" recession but could suffer in the event of a prolonged downturn.

In response to another question, Mr. Price said that credit quality would be a "soft spot" that could hold the most negative surprise, in terms of both loan losses and the possibility of another capital markets crisis.

There was some skepticism over the full-year earnings guidance, which would represent at least a 21% rise from last year. Michael Mayo of Deutsche Bank Securities asked Mr. Lewis during the call whether the projection could hold up, given B of A's core operating trends during the fourth quarter, where its earnings fell 95% from a year earlier, to an anemic $268 million, or 5 cents a share. The results were 13 cents below the average analyst estimate, according to Thomson Financial. (The company could have reported a loss had it not been for a $1.5 billion gain from selling Marsico Capital Management LLC.) Mr. Lewis responded by saying that the most significant lift would come from the Federal Reserve Board's continued preference for lowering the federal funds rate, including the 75-basis-point emergency cut announced Tuesday.

In an interview, Mr. Price said that the fourth-quarter earnings, excluding the $5.3 billion of writedowns tied to collateralized debt obligations, "were pretty strong." However, analysts also expressed heightened concerns about credit quality. Though the fourth-quarter loan-loss provision of $3.31 billion was in line with projections B of A provided last month, analysts drew attention to nonperforming assets, which rose 76% from the third quarter and 220% from a year earlier, to $5.95 billion. Mr. Lewis said during the call that most of the problems in home equity have centered on high-loan-to-value loans, "principally in states that have experienced significant decreases in home prices." However, the residential mortgage portfolio "continues to perform well."

Mr. Price said during the conference call that B of A's loan-loss provision for this year could rise 20% from the $8.39 billion it set aside last year.

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