Bank of America Under Fire

Government banking regulators have told Bank of America, the country's largest bank by assets, that it needs to plug a $34 billion capital shortfall based on results of the government's stress tests, which measure a bank's ability to withstand a deeper economic recession.

FOX Business reported last week that BofA might need a capital infusion of $36 billion or more.

The news comes after Bank of America vehemently denied earlier this week that it would need to raise $10 bn, raising questions about the bank's credibility and continuing pressure on chief executive Ken Lewis, who last week was stripped of his job as chairman by shareholders.

Last year, both Kerry Killinger of Washington Mutual and Ken Thompson of Wachovia lost their chairman titles, and both were shown the door.

The 19 companies that went through the government tests heard about the results Tuesday, reports indicate. Banks were given preliminary results of the stress tests last month, and the final results were originally scheduled for release Monday, but the Fed postponed their release after several banks objected to the findings, reports indicate.

 The exact number of banks needing more capital remains in dispute. According to Wall Street analysts now doing their own stress tests of bank balance sheets, the companies that may need to raise more capital are: Citigroup, Bank of America, Wells Fargo, PNC Financial Services Group, SunTrust Banks, Capital One Financial Corp, BB&T Corp, Regions Financial Corp, Fifth Third Bancorp, KeyCorp and GMAC.

Lewis Under Pressure

Lewis has been under pressure lately over statements made about BofA's failure to disclose deepening fourth quarter losses at Merrill Lynch, in which the bank waited until its earnings announcement in mid January to tell investors Merrill's profit problems were worse than expected.

BofA is also dealing with its troublesome acquisition of mortgage lender Countrywide Financial Corp., which faces regulatory probes and class action lawsuits over allegedly shoddy mortgage lending practices.

BofA already has received $45 bn in capital in the form of a preferred equity stake from the federal government, $20 bn of which helped it purchase Merrill, a deal BofA shareholders voted for on December 5 and which closed January 1.

BofA may be forced to convert the government's equity stake to common shares in order to bolster a measure regulators are using to test capital strength. The conversion would create massive dilution for existing shareholders, which is why BofA's share price is down dramatically.

BofA's Credibility Problem

Despite reports indicating that the 19 stress-tested banks received preliminary results about their required capital raises, eearlier this week, BofA vehemently denied a report that said the government told the bank it needed to raise at least $10 bn.

"The Financial Times report is completely inaccurate," BofA spokesman Scott Silvestri said via email. "Bank of America has not been given a final number by the Federal Reserve. The bank is not working on plans to raise $10 billion in common equity."

However, J. Steele Alphin, the bank's chief administrative officer, told the New York Times that the capital raise requested was more than triple that amount, $33.9 bn.

"We're not happy about it because it's still a big number," Alphin told the Times. "We think it should be a bit less at the end of the day." As recently as March and April, Lewis told investors that BofA didn't need any more capital. On April 20, Lewis responded to an analyst's question noting that the bank doesn't expect to require additional capital. 

Shareholders Kept in the Dark

BofA has made statements that the bank did not want to buy Merrill Lynch after it discovered deeper losses at the brokerage in December, after shareholders voted to approve the deal on December 5.  

Shareholders were kept in the dark about Merrill's eventual $15.8 bn in losses, as well as the fact that Lewis had tried to get out of the deal by going to the government, because BofA chose not to make these disclosures until the company's year-end earnings release in mid-January.

Despite the fact that BofA had installed its own accounting team at Merrill to track its problems, and despite telling the markets BofA had done its due diligence last September in just two days on Merrill Lynch, (with the help of JC Flowers, an advisory firm), Lewis attempted to invoke the material adverse conditions [MAC] clause in the merger contract at a meeting with former Treasury Secretary Henry Paulson and Fed chair Ben Bernanke in order to back out of buying Merrill in a stock swap deal valued at $50 bn in September.

When asked by investigators from New York Attorney General Andrew Cuomo's office whether he would have made the disclosures about Merrill's losses earlier, Lewis said: "It wasn't up to me" and that Paulson and Federal Reserve chairman Ben Bernanke instructed him at a meeting in December that "We do not want a public disclosure."

On the bank's year-end conference call with analysts, Lewis has said that he would not have done the Merrill deal without taxpayer money.

But Fox Business has reported, based on confidential merger documents, that Lewis could not easily walk away from the deal, given that the MAC clause was ironclad, as BofA could not walk away even in the event of negative marks to Merrill's assets, losses at Merrill Lynch, a downturn in its stock price, or even in the event of a terrorist act or war (see prior column, "Does BofA's Story Hold Up?")

To complete the Merrill deal, the Treasury, the Federal Reserve, and the FDIC have given BofA a $118 bn insurance wrap in bad assets.. To help make the Merrill deal palatable,  government regulators also gave BofA an additional $20 bn in capital to buy the brokerage, on top of the $25 bn in TARP capital the combined companies had already received.

Citigroup also won a $306 bn insurance backstop to its balance sheet, and the government. That means BofA and Citi can unload massive amounts of bad assets onto the US taxpayer.

At BofA, the bank takes the first $20.8 bn hit, with the government swallowing the remaining $97.2 bn. In the $306 bn bailout of Citi, the bank must take the first hit of $56.7 bn in writedowns, with the government taking on the remaining $249.3 bn in bad assets.

BofA spokesman Silvestri has said: "We had a transition team in place that knew about Merrill's financial performance, but financial results for November weren't known until after the December shareholder meeting."

Bernanke Fires Back

Fed Chairman Ben Bernanke told a Congressional committee at a hearing yesterday that "It is my unconditional assertion that in no way did I ever ask" BofA not to disclose Merrill's deepening losses, $15.8 bn for the fourth quarter.

Bernanke also told lawmakers he would make public his notes and correspondence from the government's meeting with Lewis.

Paulson has since said that Lewis misinterpreted the Treasury's own disclosure guidelines about the government help as being the bank's own obligations about the Merrill losses.

SEC Fires Back at BofA

And Securities and Exchange Commission chairman Mary Schapiro has scolded BofA, noting in a public address that "obligations to disclose information about losses...rests solely on the companies, not with the Treasury Secretary or Federal Reserve chairman."

Schapiro was responding to news that BofA's Lewis had told prosecutors from New York Attorney General Andrew Cuomo's office, who are investigating the bonus controversy at Merrill Lynch, that former Treasury Secretary Paulson and Federal Reserve Chairman Bernanke had told him not to discuss Merrill's deepening losses and the government's negotiations to help BofA buy Merrill.

Cuomo's office has said the SEC was kept "in the dark" about the BofA negotiations.

SEC on the Merrill Bonuses

Schapiro also says the agency is "looking closely at the quality, quantity, and the timing" of Bank of America's disclosure of its $3.6 bn in bonus payments to Merrill Lynch workers. New York Attorney General Cuomo is also investigating the acceleration of the Merrill Lynch $3.6 bn bonus payouts into December, rather than January, before the losses were disclosed to investors.

Rep. Carolyn Maloney (D-New York) asked Lewis at a February Congressional hearing about New York Attorney General's Cuomo's discovery that Merrill execs got more than $3.6 bn in bonuses just before the merger.

"Did you know how big these bonuses were going to be?" Rep. Maloney asked.

"My...involvement was very limited," Lewis said. "[Merrill] had a separate board, separate compensation committee and we had no authority to tell them what to do; just urge them what to do. So we did urge."

Former Merrill Lynch CEO John Thain has told the Wall Street Journal that top management at BofA knew full well that the bonuses would be paid out in December, before BofA's deal to buy Merrill closed January 1 and again after BofA shareholders voted for the deal on December 5^th.

FOX Business has learned that the Merrill bonus pool was part of the merger deal struck last September, a pool that was initially $5.8 bn. Lewis has said his team had 'urged' Merrill to cut the bonuses by 40%. The pool eventually dropped to $3.6 bn.

BofA spokesman Silvestri has said: "Bank of America had only a right to consult with Merrill Lynch on the bonuses and urged Merrill to reduce its bonus numbers. Merrill reduced them 40% and ultimately it was their decision to make."

BofA Scrambles

BofA is now considering the sale of an $8 bn stake in China Construction Bank in order to shore up its damaged balance on Thursday following the expiration of a lock-in period.

The move would be painful for BofA, as the Chinese bank is well positioned to take advantage of China's shovel ready, massive stimulus plan.

Already, BofA unloaded a slug of shares in the bank in order to improve its first quarter results. It got a $1.9 bn pre-tax gain from the sale of a piece of its stake in China Construction Bank, helping the profit figure for the quarter.

It also reported a $2.2 bn accounting paper gain because of the declining value of some Merrill Lynch structured notes (accounting rules enable banks to book such gains on the expectation that they will eventually repurchase the debt at a lower price). The sums virtually covered BofA's entire $4.25 bn first quarter operating profits. Merrill Lynch added $3 bn to the bank's bottom line for the period as well.

Meanwhile, BofA set aside $13.4 bn in loan loss reserves in the first quarter to cover rotten banana loans, a stunning 58% increase from just the prior fourth quarter. The sum outstripped its entire net interest income figure for the period, sending a chill down analysts' spines.

BofA's Tangible Common Equity

Government banking regulators are reportedly using a tangible common equity measure of about 4% of a bank's risk-weighted assets, up from a 3% standard.

Tangible common equity, a company's barebones net worth on a hard asset basis, a measure that is usually used in liquidation proceedings.

It's the sum you get after you subtract a company's liabilities from its tangible, hard assets, stripping out ephemera like the overpayments the bank made to buy other banks called goodwill, or the money it expects to get from servicing mortgages down the road. The TCE measure also doesn't include preferred stock, which is considered to be a debt-like instrument since these shares pay dividends.

BofA says it has about $138.9 bn in tangible common equity, or about 3% of its risk-weighted assets.

To boost that measure, BofA has been struggling to raise capital with asset sales and selling more stock, given that its shares are down 75% since it announced it would buy Merrill the weekend Lehman Bros.

BofA's Balance Sheet Holes

As I've already reported to you, BofA has got:

*$51.5 bn in bad derivatives and assets on its balance sheet

*$25.7 bn in bad loan assets

*$81 bn in off balance sheet assets

As noted, a new accounting rule that takes effect this November says all companies, including banks, must start putting back on their balance sheets these off-balance sheet sums.

As reported, the new rule will cause capital reserve ratios to gyrate faster than a compass held over the North Pole.

Lewis's Testimony

Excerpts from Lewis's testimony before prosecutors from New York Attorney General Andrew Cuomo's office:

Q: Wasn't Mr. Paulson, by his instruction, really asking Bank of America shareholders to take a good part of the hit of the Merrill losses?

Mr. Lewis: What he was doing was trying to stem financial disaster in the financial markets from his perspective.

Q: From your perspective, wasn't that one of the effects of what he was doing?

Mr. Lewis: Over the short term, yes, but we still thought we had an entity that filled two big strategic holes for us and over long term would still be an interest to the shareholders.

Q: So isn't that something that any shareholder at Bank of America who had less than a three-year time horizon would want to know?

Mr. Lewis: The situation was that everyone felt like the deal needed to be completed and to be able to say that, or that they would impose a big risk to the financial system if it would not.

Q: When you say "everyone," what do you mean?

Mr. Lewis: The people that I was talking to, Bernanke and Paulson.

Q: Had it been up to you would you have made the disclosure?

Mr. Lewis: It wasn't up to me.

Q: Had it been up to you.

Mr. Lewis: It wasn't.

Q: Why do you say it wasn't up to you? Were you instructed not to tell your shareholders what the transaction was going to be?

Mr. Lewis: I was instructed that "We do not want a public disclosure."

Q: Who said that to you?

Mr. Lewis: Paulson.

Mr. Lewis testifying as to what Mr. Paulson did not want a public disclosure of:

Q: A public disclosure of what?

Mr. Lewis: Of what they were going to be doing for us until it was completed.

Q: How about of Merrill fourth-quarter losses?

Mr. Lewis: That wasn't an issue that was being exchanged.

Q: Did anyone consider that the oral agreement was a commitment for financing, so under SEC rules there had to be a disclosure?

Mr. Lewis: I did not. That's all I can tell you.

Q: Between December 12 and the 1st of the year, did you have any conversations with anyone at bank of America or representing Bank of America, concerning whether Bank of America had an obligation to make any disclosure?

Mr. Lewis: I do not recall having any.