Does Bank of America Know What It’s Doing?

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Bank of America (NYSE:BAC) is in it deep this time since the recent announcement that regulators have suspended their plan to buy back $4 billion more shares from the bank and raise its dividend after the bank discovered a problem in its stress-test submission to the Federal Reserve.

The bank’s announcement of its capital level being reduced by three-quarters of the extra money the Fed had planned in returning to the shareholders of the bank over the next year sent the bank’s shares tumbling down 6.3 percent this week to close at $14.95, the biggest one-day decline in the stock since November 2012, Reuters noted.

The problem, according to The Wall Street Journal, were the so-called structured notes that are bonds with maturity dates paired up with derivatives such as options, and their performance being tied to a range of underlying investments including broad-market equity indexes such as the S&P 500, emerging market currencies, and commodities.

Merrill Lynch said in a statement that the lender will resubmit its proposal after finding the flawed accounting in its books. Ironically enough, according to Bloomberg, Bank of America CEO Brian Moynihan had planned to quintuple his quarterly payout to 5 cents a share, five years after the bank cut the dividend to the value of a token during the financial crisis.

David Hilder, an analyst at Drexel Hamilton LLC in New York, told Bloomberg over the phone that Bank of America is not the first to make a mistake with its CCAR (Federal Reserve Comprehensive Capital Analysis and Review), and that while the bank noticed the error and has enough capital to cover the payout, the setback is notably “embarrassing” for the bank.

Mayra Valladares, a managing principal at MRV Associates, a capital markets and financial regulatory consulting and training firm in New York, told The New York Times that the neglect toward accounting for structured notes after the Bank of America takeover of Merrill should not have surprised the market.

“The more complex they are, the harder it is to even find data to properly value them and to measure their credit, market, operational, and liquidity risks,” Valladares said. “Anyone who claims that valuing structured products and measuring their risks is easy I being blinded by the chase for yield.”

Valladares said that given that BofA has to resubmit its capital plan to the Federal Reserve, the market will likely be less trustworthy toward the Fed’s annual review of capital plans for the big banks.

Emre Carr, a principal with the Berkeley Research Group, told Compliance Week that this definitely raises questions about the type of internal quality control BofA practices. “When you have a trillion dollar balance sheet, you are going to see errors and mistakes,” Carr said. “How much is acceptable and how much can you tolerate?” Carr believes a deep investigation wouldn’t be out of the question for proper quality control practices.

Famed Economist Joseph Schumpeter wrote in a blog post for The Economist that he thinks this is telling of the intelligence they had toward these structured notes.

“It is a safe guess that many of BofA’s shareholders had no understanding of either approach, and weren’t waiting for answers,” Schumpeter wrote. “That the stock rebounded a bit and then slid further, however, suggested that their skepticism was more than a short-term reaction.”

Since 2008 when Merrill Lynch acquired Bank of America through the Fed and Treasury helping put these banks together to create the “too big to fail” banks one often hears about, Bank of America has been on a slippery slope. As it has been eliminating personnel left and right since 2011 when it planned to save $5 billion annually by eliminating 36,000 employees, it is no secret the bank as a firm is having issues.

Not only can the bank not keep an eye on its books but the fact that its plan in 2012 to eliminate 16,000 jobs turned to 30,000 jobs under a program called Project New BAC after a decline in revenue, new regulations, and a slow economy does not help justify the firm’s health.

Suffice it to say, Bank of America and Merrill Lynch have their work cut out for them this time.

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