Bank of America: Doubts Remain

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's largest mortgage lender is designed to help BofA dominate the mortgage industry in the long term. But in the near term, the Countrywide buyout brings BofA lots of trouble. The quality of Countrywide's loans is much worse than the loans on BofA's balance sheet. BofA said July 21 it will need to deal with $40 billion in troubled mortgage loans at Countrywide.

When BofA brought Countrywide's loans onto its own balance sheet, it did so at a hefty 15% discount. In other words, BofA is already assuming a sizeable level of future losses on Countrywide's portfolio. So, Countrywide losses won't hurt BofA's bottom line unless they increase beyond this level. Also, BofA has set aside billions of dollars to absorb its own losses in future quarters. BofA issued new stock last quarter, raising about $7 billion in new capital.

Legal Troubles Loom at Countrywide

Even after that move, S&P's Plesser is worried that BofA is still not prepared for large credit losses. He says he's watching three key factors that should determine how far and fast credit quality slides: the unemployment rate, the level of gas prices, and falling home prices.

The Countrywide purchase remains "a big question mark," Morningstar's Peters says. Though future losses on Countrywide's portfolio worry some analysts, Peters says investors' main worry "is the stuff they can't quantify right now," especially a multitude of lawsuits and investigations directed at Countrywide's lending policies.

In the past week, investors have been buying bank stocks that have gotten beaten down. BofA shares are still down 31% from the start of the year. "The market has painted our industry with a broad brush," Lewis at BofA said. "It seems to me that there is a big difference between those banks that are diversified and those banks with a concentration of funding issues."

The Strong Get Stronger

This earnings season may give investors a read on which banks are well-positioned to survive the credit crisis. "The stronger banks are getting stronger," Plesser at S&P says. "And the weaker ones are getting weaker," particularly those banks that might "need to raise capital in this environment."

Unfortunately, the rocky economy, rising credit losses, and especially the acquisition of Countrywide make it tough to be certain just how strong Bank of America really is.

Steverman is a reporter for BusinessWeek's Investing channel.