BofA: Too big to fail a math test
Bank of America has joined Citi in the dubious group of banks who have failed the Fed’s stress test twice. The Federal Reserve announced yesterday that the bank would have to resubmit its capital plan due to incorrectly reported data.
While BofA made an accounting mistake, and a rather egregious one, the Fed also failed to spot the error the first time around. Ben White quotes an unnamed senior bank executive performing blame jujitsu: “Easy to blame BofA here but seems like some of the blame goes to the opaque design and implementation of stress testing by the Fed”.
Last month, the Fed approved Bank of America’s plan for a $4 billion share buyback and a $1.5 billion dividend increase. Now, after BofA found problems in its capital calculations, it is halting those plans and will submit a new plan to the Fed. The bank’s error was in calculating the value of a set of structured notes issued by Merrill Lynch in 2009. The WSJ’s Michael Rapoport explains the rule that tripped up BofA, called the “fair value option”:
The issue goes back to the 2007 accounting rule that granted banks a “fair value option” – the opportunity to value some of their debt at market value, or the best approximation of it, instead of at their original cost.
When making the calculation to get from its capital under accounting rules to its regulatory capital, BofA stripped out “unrealized” changes on those structured notes – i.e., the paper gains and losses on notes it still held. But the bank also stripped out “realized” losses on structured notes that had matured or been redeemed – and it wasn’t supposed to do so.
Bank of America isn’t likely to find solace in the fact that the mistake it made won’t even be a mistake much longer: Floyd Norris notes that just last week the “Financial Accounting Standards Board tentatively agreed, on a 5-to-2 vote, to end that practice at a date to be determined”.
Peter Eavis and Michael Corkery write that while the banks submit their own calculations in the stress test, the “Fed is also meant to review the banks’ numbers, using its own examination to identify potential red flags”. Eavis and Corkery quote CLSA bank analyst Michael Mayo, who bluntly puts the onus on Bank of America: “It’s a bank. It needs to get the numbers right”. Actuarial sprezzatura may have been cool in Medici Florence, but it’s shocking, and trust-depleting, at a modern global financial institution.
Matt Levine echoes Mayo’s point. Bank of America overstated its capital, Levine estimates, by $2.7 billion under current rules, and $4 billion under the not yet implemented international Basel 3 regulation. While the rules that led to the mistake are complex and counterintuitive, Levine says, “the people doing your regulatory capital calculations really ought to know how to do regulatory capital calculations! ‘The rules are hard’ is not a good excuse for a $2 trillion bank”. — Ben Walsh
On to today’s links: