Bank of America Fighting to Keep Dividend Hike After $4 Billion Blunder

The note valuation error is ‘a step backwards for them,’ says one institutional investor, and ‘raises credibility issues’

CEO Brian Moynihan of Bank of America. (Photo: AP) CEO Brian Moynihan of Bank of America. (Photo: AP)

Bank of America Corp. (BAC) Chief Executive Officer Brian T. Moynihan won permission last month for the firm's first dividend increase since the financial crisis. Now he's under pressure to salvage the payout after the company mistakenly inflated capital levels by about $4 billion.

One leading option: scrapping a $4 billion share repurchase, said a person briefed on the deliberations. That could allow the Charlotte, North Carolina-based bank to resubmit its request to boost the quarterly dividend to 5 cents, said the person, asking not to be identified because the process is confidential.

Moynihan, 54, has a month to draw up plans that will win Federal Reserve approval after the regulator asked the bank to freeze buybacks and dividend increases. The boost approved in March was heralded as a symbolic victory for Moynihan and the bank, which has had a token penny-a-share payout since 2009.

“This is a step backwards for them, it raises credibility issues for management,” said Jonathan Finger, whose family-owned investment firm, Finger Interests Ltd., owns 900,000 shares of the lender and stands to lose about $144,000 in annual income if Moynihan fails to increase the dividend. “Shareholders have suffered a significant period with no dividends, so some respite from that would be welcomed.”

Bank of America, the nation’s second-largest bank, views the dividend as linked to the company’s ability to generate regular earnings, which was unaffected by the mistake, said the person. The firm isn’t yet certain what payout it will request and may refine the proposal until the due date, the person said.

Outside Review

The predicament arose after the bank found an error in how it valued structured notes inherited in its 2009 acquisition of Merrill Lynch. The Fed responded by asking the firm to resubmit parts of its stress-test capital plan, which is designed to prove that a bank is strong enough to survive an economic shock. Bank of America disclosed the situation yesterday, saying it was hiring an outside firm to review its processes before the resubmission.

The bank’s estimate of Tier 1 capital under coming rules fell to $130.1 billion from $134.2 billion because of the error, the firm said yesterday in a regulatory filing.

The resubmission probably will face closer Fed scrutiny and a higher risk of rejection, said Erik Gordon, a professor at the Ross School of Business at the University of Michigan in Ann Arbor.

Lower Payouts

The bank’s blunder doesn’t necessarily mean the Fed will reject a revised capital plan on qualitative grounds, as the regulator did with Citigroup Inc.’s proposal, said another person with knowledge of the process. Examiners can’t check all the data provided by banks, the person said.

The Fed regards the incident as bolstering the case for the stress tests because the discovery was handled swiftly, said Barbara Hagenbaugh, a spokeswoman for the central bank. Before the stress tests, finding and fixing the error probably would have been a drawn-out process, she said.

The bank said the revised proposal probably will include lower payouts than the earlier plan, which was already modified once to win Fed approval during the stress tests. At stake are $1.68 billion in annual dividend payments for a company that earned more than $10 billion last year. Before the financial crisis, stockholders were getting quarterly payments of 64 cents a share.

Bank of America shares swung to a loss for this year by tumbling 6.3 percent yesterday to $14.95, the biggest drop since November 2012. They were little changed today at 9:35 a.m. in New York.

Raising Doubts

The slide was overdone in light of the firm’s capital levels, wrote Betsy Graseck, a bank analyst at Morgan Stanley. Bank of America probably will forgo buybacks while keeping the dividend increase in the resubmission, Graseck predicted. Mike Mayo, who covers banks at CLSA Ltd., said the mistake raises doubt about controls and reiterated his sell recommendation.

Bank of America discovered the mistake late last week while preparing a quarterly regulatory report and immediately notified the Fed, said a person with direct knowledge of the process. The error had gone undetected since the firm’s acquisition of Merrill Lynch, said the person.

The bank, in its calculation of regulatory capital, erroneously included a credit for structured notes that had matured, said the person. The company had about $30 billion in the securities at the end of 2013, the person said.

Banks create structured notes by packaging debt with derivatives to offer customized bets to retail investors while earning fees and raising money. Derivatives are contracts with values derived from stocks, bonds, commodities and currencies, or events such as changes in interest rates or the weather.

Citigroup’s Rejection

Even after correcting the mistake, Bank of America has a 9% common equity Tier 1 capital ratio as of March 31, beyond the 8.5% required by 2019 under the latest international rules set by the Basel Committee on Banking Supervision.

The firm, led by Moynihan since 2010, has worked for years to resolve headaches inherited with his predecessor’s decision to buy Merrill Lynch and mortgage-lender Countrywide Financial Corp. during the financial crisis. The company reported a $276 million deficit for the three months ended March 31, its fourth quarterly loss under Moynihan.

Terry Laughlin, Bank of America’s former chief risk officer who last week was named president of strategic initiatives, will help manage the resubmission, according to one of the people. Laughlin will establish the scope of what must be resubmitted and work with Chief Financial Officer Bruce Thompson and Geoffrey Greener, Laughlin’s successor as risk officer.

The Fed rejected Citigroup’s plan last month by faulting the quality of the New York-based firm’s processes. Citigroup, the nation’s third-largest bank, also was seeking its first dividend increase since the crisis as well as a stock buyback.

 

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