Regulators Ask Bank of America About Contingency Plans

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Regulators Ask Bank of America About Contingency Plans

The Feds appear to be taking the risk that Bank of America might go wobbly seriously, but are they taking it seriously enough?

We quoted Tom Adams on the matter of the Buffett investment in the Charlotte bank:

This is being spun as good news for BofA but it is really a sign of just how much trouble they are in. This is step one of their rescue. The powers that be felt they could not wait any longer with BofA so damaged, and that a run or crisis was one bad news day away (earlier this week I predicted some rescue action within 2-3 weeks). Step two, some additional lifeline will show up in September. Step three will be a sale of Merrill.

Some readers rejected the idea that a Merrill separation would ever be in the cards, given that Bank of America has made a great deal of noise about how it has integrated the securities firm. But the fact is that Merrill, or any of the major capital markets players would be well nigh impossible to resolve without having serious market impact. Harvey Miller, the dean of the American bankruptcy bar, was quoted in Too Big Too Fail as saying that winding down a mere midsized US securities firm was a highly disruptive event. Not that Merrill would have to be wound down, but if the old BofA foundered and Merrill had been knit tightly into the commercial banking operations, it could be extremely difficult to reverse the deal.

A story in the Wall Street Journal indicates that the bank has considered some preliminary measures in its contingency plans:

Executives of the bank recently responded to the unusual request from the Federal Reserve with a list of options that includes the issuance of a separate class of shares tied to the performance of its Merrill Lynch securities unit, these people said. Bank of America purchased Merrill Lynch in 2009, and it has become the bank’s most profitable division.

Chief Executive Brian Moynihan isn’t expected to pull the trigger soon, if ever, on the creation of a so-called Merrill Lynch tracking stock. Such a move would raise money from investors but could be viewed as counter to Mr. Moynihan’s strategy of knitting together the disparate parts of the franchise into a cohesive whole. Its inclusion on the list as a theoretical option shows the bank is considering all possibilities as it wrestles with an array of problems weighing down its shares….

The Fed’s call for more documentation about what the bank might do in more-extreme circumstances was a response to uncertainty about a U.S. economic recovery and a downward swing in Bank of America’s share price earlier this year, one of these people said. It was a one-time request, although the Fed has done the same with other firms in the past.

Bank of America did the analysis at the Fed’s request in late July and early August and then provided the Fed with its menu of options, said people familiar with the situation. Some items, such as the tracking stock, were more theoretical than others.

Mr. Moynihan isn’t giving the tracking stock serious consideration at this point, said a person familiar with the situation, but he included it on the list to show the company has multiple levers to pull.

I must stress, as the Journal does, that no action of this sort appears to be imminent. However, Bank of America’s mortgage woes appear to be worsening by the day. If Europe goes into a full-blown crisis, investors will dump investments they perceive to be risky first and ask questions later, and BofA is very likely to be caught in the downdraft. One gets the strong impression that management does not appreciate how real this risk is. Thus while regulatory prodding to develop contingency plans is in theory a sound measure, in practice they won’t do much good if management refuses to believe that they might be needed.