Is Bank of America preparing for a Chapter 11?

October 19, 2011

Bank of America has managed to step into the kimchee several times over the past couple of months, an achievement that only warms the hearts of crisis communications professionals. First came the abortive settlement of $10 billion or so in put-back claims by some large investors. The State of New York and anyone else paying attention intervened. Settlement is now mostly muerto in political terms, although the big investors are still paying the big lawyers to soldier on in hope of forcing a settlement on all parties.  Only in New York are such things possible.

Then came the decision by Bank America CEO Brian Moynihan to impose a $5 per month fee on ATM transactions, this in response to the Dodd-Frank law which cuts about half of the profits for big banks in the electronic payments market. Consumers reacted in rage to the announcement, which arguably helped to catalyze the Occupy Wall Street movement. Truth is that the big bank’s cartel control in payments is under assault by more than Congress. Think technology, Apple and Google, and stay tuned for a future post on the payments revolution. Steve Jobs does get the last laugh on the big banks.

Most recently Bank America drew attention to itself by disclosing that it had moved all of the derivatives footings from its Merrill Lynch subsidiary to the lead bank, Bank of America N.A. Bloomberg ran the first story, reporting “BofA Said to Split Regulators Over Moving Merrill Derivatives to Bank Unit.” This report led to comments and reports claiming that the Fed, by allowing this move, had somehow impaired the national patrimony and violated Section 23A of the Federal Reserve Act. Section 23A is among the more bizarre parts of the Fed’s enabling law and governs transactions between banks and affiliates.

Bill Black of University of Kansas City told me that the Bank America move was not merely an administrative exercise. “Here, B of A was not the counterparty,” says Black. “The 23A issue is moving an exposure [from Merrill Lynch] that is in trouble to the insured institution, apparently at book value, from an uninsured affiliate. That should be an easy call: ‘No.’ The Fed cares about BHCs and is institutionally primed to say yes to this kind of deal, while the FDIC is institutionally primed to protect the FDIC insurance fund.”

While I am sympathetic to concerns about potential losses to the FDIC bank insurance fund, the fact is that FDIC can reject any contract between any party and a failed bank. Truth to tell, however, such changes in the counterparty for OTC derivatives exposures are not that surprising for people who follow the securities industry. Goldman Sachs, Morgan Stanley, et al have moved their swaps business “in the bank” long ago. As Bloomberg notes, 99% of all of JPMorgan’s swap book flows through the lead bank. And yes, the Merrill business was particularly exotic, but keeping it in Merrill running through the smaller, FDIC insured Merrill depositories would probably be more of a risk to the Bank America group.

So the real question is why now? Susan Webber of Aurora Advisers, in her Yves Smith nom de plume on Naked Capitalism, commented on the motives behind and timing of the change:

You can argue that this is just normal business, the other big banks have their derivatives operations largely in the depositary. But BofA has owned Merrill for over a year and a half, and didn’t undertake this move until it was downgraded. Goldman and Morgan Stanley remaining big players in this business and don’t have a large depositary. If this was all normal business, BofA would have done this a while ago, and not in response to market pressure, and they would have gotten the FDIC on board. The way this was done says something is amiss.

Correct. To my earlier post regarding the need for a restructuring at BAC, “Housing, debt ceilings & zombie banks,” the move to put the derivatives exposures of Merrill Lynch under the lead bank could be preparatory to a Chapter 11 filing by the parent company. The move by Fannie Mae to take a large chunks of loans out of BAC, the efforts to integrate parts of Merrill Lynch into the bank units earlier this year, and now the wholesale shift of derivatives exposure all suggest a larger agenda.

I don’t have any access to inside skinny, but what I see suggests to this investment banker that a restructuring may impend at Bank of America. In the event, that is good news in a sense that this continuing distraction to the financial markets will be headed for a final resolution.


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Or, is this a stall-inducing push-back against the state AGs (NY, CA, KY, MA) that are pressing the issue of restructuring vis a vis blockage of the settlement that gets rid of outstanding reps and warranties (and NY in particular, with its separate investigation)?

If the move now means the FDIC is on the hook for a large chunk of the Merrill derivatives whereas before the impact to the FDIC insurance fund would have been negligible, this might give the AGs pause in light of their recent PR coup.

Posted by E_B | Report as abusive

If the Eurozone crisis implodes/explodes, the pressures on B of A to restructure could increase dramatically. It’s good to be prepared.

Posted by breezinthru | Report as abusive

Why now? That’s simple. They’re ending the Federal Reserve and the Bank Holding Company Act in one fell swoop. Time to be like James Brown and “Get on the good foot.” Forget Sandy Weill and the “financial supermarket”…. the banks will actually own the supermarket (i.e. butcher, baker and candlestick maker).

Dave Harrison

Posted by daveharrison | Report as abusive

Here’s another possible explanation:

The likelihood of a downgrade is lower with the bank as the CP instead of the broker-dealer. This, in turn, lowers the risk of massive contract unwinds from downgrade triggers in the swaps agreements.

Posted by Ivan_F | Report as abusive

I always enjoy Chris Whalen’s commentary but I must admit that I have been disappointed with his commentary regarding BAC over the last year or so. He generally (not always) raises points that have some validity and are perfectly enjoyable to read but he has ignored key points for reasons that I am not sure of.

Two key points that he is ignoring here:

1) Merrill Lynch would have compensated the bank holding company for absorbing the risk relating to these instruments. His article makes it sound like they are moving assets/liabilities around between legal entities at something other than fair value which is the equivalent of accusing them of fraud.

Sales between legal entities are quite common are they not Mr. Whalen?

2) Exactly how would a sale from Merrill to the banking subsidiary be an indication of a bankruptcy filing by the parent Mr. Whalen? If you are talking about a sale from the holding company maybe there is an argument but this simply is not the case now is it Mr. Whalen?

Very disturbing that a man with your intelligence and skills has gone down this route.

One other question for you Mr. Whalen. You wrote about the potential for Countrywide being bankruptcy remote back in 2008. Exactly why do you ignore this possibility now? It is an important issue and I would encourage you to write about this once again although I would sure appreciate some balance for a change as opposed to ax jobs.

Posted by JeffBoyd | Report as abusive

As stated in article other banks have already done this and BAC may finally have been advised to do this with their recent re-org and “new BAC” plan. Also, it seems that this makes sense if they put Countrywide into bankruptcy (the source of most the problems) which, according to BAC comments a few months ago has been kept as a separate entity.

Posted by SC81 | Report as abusive

Banks have had to try to absorb almost a Trillion in foreclosures and now they’re the target of even more hate! My question: how many of the flakes that lied about their income to gamble on a home miles above their means have been prosecuted? You know the ones that have stopped making house payments and have lived for free for years, then they sell off parts of the house and send the salvage back to the tax payer! Start in Nevada! All ya need to do is ask for W2s from these flakes when they give it back to us! It’s a Fed Offense FYI to lie on a Fed backed mortgage loan doc and I’d bet millions did-and most of Nevada!

Posted by DrJJJJ | Report as abusive

“the Dodd-Frank law which cuts about half of the profits for big banks in the electronic payments market.”… I want this bs statement proved…. Tell me EXACTLY HOW D-F cuts about half of the profits for banks…. Tell me… EXACTLY…. I want proof….
BoA should not be allowed to file bankruptcy… they should be prosecuted for fraud, violation of SEC rules, violations of banking rules and regulations…
These people need to see jail time… I steal $10 and go to jail for 10 years, these people steal 10 billion and get a bonus… And you call that capitalism…. I call it grand theft…

Posted by edgyinchina | Report as abusive

I am sorry you have thrown your lot in with folks like Henry Bloget having given up analysis and moved into the propaganda business. This is a shame.

You wrote a reasonable article back in 2008 about Countrywide being bankruptcy remote. Why don’t you write an article on that topic again? You keep writing as though Bank of America has absorbed all the potential liabilities and I think you know that this simply is an argument that has been rejected by all but a single New York judge who has allowed discovery on the topic to proceed. Allowing discovery is a long way from saying BAC is liable but you continue to ignore this simple fact along with the decisions from courts in other States. How about it Mr. Whalen? You are a very bright fellow, why not write an article on the topic?

Now you write an article saying that Merrill Lynch selling some derivative contracts to the bank holding company is an indication that the parent company is about to file bankruptcy. This is so absolutely weird that I have a hard time even knowing what questions to ask. How is this for a starter, every company I have ever worked for had transactions between different subsidiaries for good business purposes and yet none of them ever filed bankruptcy. I’m just completely baffled as to why you would write something so misleading when I think you know better.

Oh well. I guess this sort of thing is the way of the world. Maybe I’m just missing something but I think your intent is to create fear and we all know how fear and panic impacts banks.

Posted by JeffBoyd | Report as abusive

These are certainly interesting and shaky times economically and politically. The crimes by the government must unravel and get exposed.

I’m just one of the average 99% with kids and a mortgage struggling from month to month to cover the bills to feed my kids and be able to get to work.

Above are big topics – flying way above my head but I would appreciate if someone could explain the consequences IF Bank of America fails and goes down?

Seems like there is a bad outcome either way; bailed out by the Fed will create outrage and a crashed dollar and crashed Wallstreet.

Could someone elaborate on the consequences in the scenarios that are alive and playing?

If everyone emty out their savings on the 5 November so there is no cash in the big banks – what will happen?

Will this cause the dollar to crash and maybe other major currencies to soar?

Posted by Whyzat | Report as abusive

@ Whyzat:

What happened after Lehman x 3 would likely be the short-term effects of a potential BAC bankruptcy.

Posted by OOPSIE123 | Report as abusive

Makes sense to me; BOA is transferring risky debt to the parent company so that it is covered by the FDIC during a bankruptcy. I don’t know if there is any truth to it, but it is plausible. Unsavory, but possible.

Posted by stevedebi | Report as abusive

Tank of America is in sooo much more trouble than they want anyone to believe. I’ll give you just one example of why this is true. ReconTrust Co. the repo arm of B of A is a wholly owned subsidiary of that bank that is responsible for running the foreclosure auctions of B of A. In one state alone RepoTrust website lists more than 5000 homes to be sold at auction.
The problem is that many of the “assignments” are illegal since either the entity making the assignment lacks legal standing in the matter since it is not a legal party of interest. Parties with no legal claim can not assign anyone to do anything.
The contract is a nullity and any subsequent sale would be voided immediately by even the lowest Court in the land and expose the seller to damages in further litigation. This in conjunction with clearly separating the Deed of Trust from the actual Promissory Note breaks the Chain of Title further voiding any claim a Trustee may try to assert in moving the action forward or assigning a different Beneficiary or Trustee to acts on its behalf. I have attended several of these auctions and I can say each time I have attended not one person is bidding on the sale of those properties. It reeks of the SEC v. Deutsche Bank lawsuit when DB was fined $25 million for padding their auctions and buying their own properties to artificially inflate their sale rates.
If that turns out to be the case here, Tank of America is going down.

Posted by echobravotango | Report as abusive