Traders work at the post that handles Bank of America on the floor of the New York Stock Exchange, Monday, April 28, 2014. Bank of America sank 5 percent, to $15.14 after the bank unexpectedly announced it would suspend its stock buyback program and its plan to raise its quarterly dividend. The bank said it discovered an error in how the bank calculates its capital ratio, a crucial measure of a bank's strength.Richard Drew/The Associated Press
If you're nervous about the size and complexity of today's mega-banks, then the latest news from Bank of America Corp. will leave you even more on edge.
The bank announced Monday that it had overstated its capital ratios for regulatory purposes due to an error in its calculations. The mistake dates back to its acquisition of Merrill Lynch & Co. during the financial crisis.
Once it grasped the problem, the bank informed regulators – who promptly ordered it to suspend a $4-billion (U.S.) share buyback and an increase in its dividend (oh, to be a fly on the wall for that conversation.) Just last month, the same regulators approved Bank of America's plan to return money to shareholders and said that it had passed its annual "stress test."
It's little surprise that Monday's admission gave investors an anxiety attack. They sent the bank's shares down 6.3 per cent in the worst trading day for Bank of America since 2012. The tumble erased the stock's gains so far this year and obliterated billions of dollars of market value.
One reason investors are worried has to do with precedent. In March, regulators delivered a stinging setback to Citigroup Inc. when they revealed that the bank had failed its annual stress test. The failure was the result of problems with the way the bank had calculated its capital cushion – in other words, problems that Bank of America appears to share.
As punishment, Citigroup must stick with its paltry token dividend. Its shareholders are in a kind of limbo as the bank decides whether to submit a fresh plan for dividends and buybacks to regulators for their approval. Now investors in Bank of America find themselves in a similar kind of purgatory (for its part, the bank has said it will deliver a new plan to the Fed "expeditiously.")
"If you disappoint the dividend seekers in this kind of a market, then it casts a pall over the market action for your stock," said Sam Stovall, chief investment strategist at S&P Capital IQ in New York.
Bank of America is also facing pressure on other fronts. It has entered negotiations with U.S. prosecutors to reach a settlement related to its sale of mortgage-backed bonds prior to the financial crisis. The final tab could be more than $10-billion.
The blunder revealed Monday is unusual but not colossal. It relates to the accounting treatment of structured notes that the bank assumed when it completed its purchase of Merrill Lynch in 2009. The bank said that it had erred in the way it accounted for losses on such debt when it matured – in effect, stripping them out when it shouldn't have. The mistake applies solely to its submissions to regulators; for the purposes of financial reporting, Bank of America is in the clear.
The upshot of the error is that Bank of America's estimated tier one capital ratio is actually 11.9 per cent, 21 basis points lower than initially reported (a basis point is a hundredth of a percentage point). That's still above the minimum threshold required by regulators.
The fact that the slip-up doesn't have a massive impact on the capital ratio is unlikely to reassure investors, who now find themselves seized by a host of questions. Why didn't regulators uncover the mistake themselves? Why did it take the bank so long to notice it? And perhaps most importantly, do any other skeletons lurk in the vastness of Bank of America's closets?