Tag Archives: Bank of America

Why Did Bank of America Pay Back the Money?

Everybody knows by now that Bank of America is buying back the $45 billion of preferred stock that the government currently owns. While the reason why they are doing this is obvious, I’m going to pretend it isn’t for a few paragraphs.

Buying back stock costs money — real cash money. Why would a company ever do such a thing? The textbook answer is that a company should do it if it doesn’t have investment opportunities that yield more than its cost of capital. The cash in its bank account, in some sense, belongs to its shareholders, who expect a certain return. If the bank can’t earn that return with the cash, it should return it to the shareholders. In this case, though, the interest rate on the preferred shares is only 5%, which is far lower than usual cost of equity. In fact, Bank of America just issued $19 billion of new stock in order to help buy back the government’s preferred stock. The cost of that new equity (in corporate finance terms) is certainly higher than 5%. In other words, Bank of America just threw money away.

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Accounting at B of A and Fannie

Via Yves Smith, John Hempton analyzes the quarterly results of Bank of America (so-so) and Fannie Mae (terrible). The underlying issue is that bank quarter-to-quarter results are largely driven by the amount of provisions they take against future loan losses. You can think of this as a very rough approximation to marking-to-market — instead of waiting for the loans to default, you estimate how many loans will default in the future (that estimate should change as the economic situation changes) and put that amount of money into reserves. Then when the defaults actually happen, you take the money out of reserves.

Hempton argues that Bank of America and Fannie Mae are estimating extremely different future loan losses, and those differences cannot be attributed to differences in their current performance (the rate at which loans are defaulting now). If I wanted to be provocative I would only show you this quote:

If Bank of America were to provide at the same rate its quarterly losses would be 50-80 billion and it would be completely bereft of capital – it would be totally cactus. It would be – like Fannie Mae – a zombie government property.” [emphasis in original]

(“Totally cactus” — I like that.)

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More on Bank of America

Last Wednesday I wrote a highly critical post about the agreement between Bank of America(BAC)  and the government (Treasury, the Fed, and the FDIC) to terminate BAC’s asset guarantee agreement in exchange for a payment of $425 million. I’ve learned some more about this and I think I can reconstruct the government’s perspective on this issue, with the help of someone knowledgeable about the transaction.

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Bank of America $4 Billion, Taxpayers $425 Million

I’m trying to figure out if I should be infuriated about the agreement allowing Bank of America to walk away from the asset guarantees it got as part of its January bailout in exchange for a payment of $425 million. I can piece together part of the story from The New York Times, Bloomberg, and NPR, but the complete story is a bit hazy.

The initial deal was that Treasury, the FDIC, and the Fed would guarantee losses on a $118 billion portfolio of assets; B of A would absorb the first $10 billion and 10% of any further losses, so the government’s maximum exposure would be about $97 billion. Part of that guarantee was a non-recourse loan commitment from the Fed, basically meaning that the Fed would loan money to B of A, take the assets as collateral, and agree to keep the assets in lieu of being paid back at B of A’s option. In exchange, the government would get:

(a) An annual fee of 20 basis points on the Fed’s loan commitment, even when undrawn (if B of A drew down the loan, which it didn’t, it would pay a real interest rate). The loan commitment could be interpreted to be only $97 billion, so this comes to $194 million per year.

(b) $4 billion of preferred stock with an 8% dividend. That’s a dividend of $320 million per year; B of A can buy back the preferred stock by paying $4 billion.

(c) Warrants on $400 million of B of A stock. B of A was at $7.18 the day the bailout was announced and yesterday it closed at $17.61, so if Treasury had gotten an exercise price of $7.18, those warrants would be worth about $580 million now.

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Benefits of Size?

Felix Salmon points out that Bank of America can now charge customers overdraft fees ten times a day (up from five). (Read the original Washington Post article if you want to be aggravated.) Well, I can do one better.

I recently had to track down some past bank records. Local banks? No problem, no fee. At Bank of America, however, they insisted on charging me $5 per page – even though they were breaking a state law forbidding them from charging a fee. (All I’ll say is that they weren’t allowed to charge a fee because of the characteristics of the person I was getting the records for and the purpose for which he needed the records.) I pointed out to the drone at the bank that she was breaking the law, but she insisted she couldn’t do anything about it and we would have to sue them to get the money back. And I believe her; the problem is almost certainly that requests go from the local branch to some central processing center, and there is no way for the local branch to tell the central processing center not to deduct the fee from your account.

Now perhaps this central processing center setup reduces costs for Bank of America. But do they charge lower mortgage rates? No. Do they offer higher savings rates? No. Are they too big to fail? Absolutely. Do things have to be this way?

Update: Some people have pointed out that you don’t actually have to sue B of A to get your money back. That is correct. In my state you can send them a demand letter and they should pay you. However, the problem is that because you are dealing with your bank, they can just deduct the money from your account and force you to fight them to get it back. And most people don’t want to deal with that.

By James Kwak

Bank of America Gets Quite a Deal

We have a deal.  You, the US taxpayer, have generously provided to Bank of America the following: one Treasury-FDIC guarantee “against the possibility of unusually large losses” on a pool of assets taken over from Merrill Lynch to the tune of $118bn, and a further Fed back stop if the Treasury-FDIC piece is not enough.  In return we receive $4bn of preferred shares and a small amount of warrants “as a fee”.  There is a $10bn “deductible,” i.e., BoA pays the first $10bn in losses, then remaining losses are paid 90% by the government and 10% by BoA.

We are also investing $20bn in preferred equity, with a 8 percent dividend.  There will be constraints on executive compensation and BoA will implement a mortgage loan modification program.  Essentially, this is the same deal that Citigroup received just before Thanksgiving, known as Citigroup II, which was generous to bank shareholders but not good value for the taxpayer.

This is more of the same incoherent Policy By Deal that has failed to stabilize the financial system, while also greatly annoying pretty much everyone on Capitol Hill.  Hopefully, it is the last gasp of the Paulson strategy and the Obama team will shortly unveil a more systematic approach to bank recapitalization; it would be a major mistake to continue in the Citi II/BoA II vein.

In addition, you might ponder the following issues raised by the term sheet

1. The $118bn contains assets with a current book value of up to $37bn plus derivatives with a maximum future loss of up to $81bn.  This is more detail than we got in the Citi deal, so there is evidently greater sensitivity to calls for transparency.  But the maximum future loss is based on “valuations agreed between institution and USG.”  What is the exact basis for these valuations?  From the term sheet, it sounds like we are talking mostly about derivatives that reference underlying residential mortgages.  Absent any other information, my guess is that they can easily lose more than $81bn – depending on how the macroeconomy and housing market turn out.

2. What is the strike price of the warrants?  This was controversial in the Citigroup II deal (because it was unreasonably high), but at least it was quite explicit up front.  The announcement is suspiciously quiet on this point, perhaps due to the recent spotlight on warrant pricing terms.

3. What kind of reporting will there be by BoA to Treasury, and what will be disclosed to Congress, in terms of the exact securities covered by this guarantee and how they perform?  The lack of information is a big reason why TARP became discredited and Capitol Hill is so concerned to see more transparency going forward.  There is nothing in the term sheet that reveals the true governance mechanisms that will be put in place, or how information will be shared with the people whose money is at stake (you and me, or our elected representatives).  I understand there is market-sensitive information present, but there are obviously well-established ways to share confidential information with members of Congress.

Overall, it feels like the latest (and hopefully the last) in a long line of ad hoc deals, which have done very little to help the economy turn the corner.  The new fiscal stimulus needs to be supported by a proper bank recapitalization program, as well as by a large scale initiative on housing.