May 20 (Bloomberg) -- Wachovia Corp. and Fifth Third Bancorp, U.S. banks that tried to profit by taking out life insurance on their employees, now face losses because the policies held the same types of investments that led to the global credit crunch.

Wachovia reported a $315 million first-quarter loss in its bank-owned life insurance program, known as BOLI, because of investments in hedge funds managed by Citigroup Inc. Fifth Third said in a lawsuit filed last month that it had losses of $323 million from Citigroup's Falcon funds, which slumped more than 50 percent in the past year as the subprime market collapsed.

The BOLI-related writedowns add to an erosion of capital that's leaving banks, including Charlotte, North Carolina-based Wachovia and Fifth Third of Cincinnati, with their worst earnings outlook in more than a decade. Total BOLI holdings of U.S. banks topped $120 billion at the end of 2007, according to data compiled by Michael White Associates LLC in Radnor, Pennsylvania.

``A lot more people are going to take a lot more losses,'' said Adam Savett, a vice president at New York-based RiskMetrics Group Inc., which studies corporate risk. ``We are seeing just the tippy-top of the iceberg.''

Bank of America Corp. had $16.2 billion of BOLI assets as of March 31, followed by Wachovia's $14.8 billion, regulatory filings show. Losses from the BOLI programs were reported earlier today by the Wall Street Journal.

Wachovia declined 2.4 percent to $26.70 in New York Stock Exchange composite trading at 10:13 a.m. Fifth Third fell 2.9 percent to $19.87.

Insurance Salesmen

BOLI gained in popularity during the 1990s after Congress limited the amount banks could deduct on municipal bond investments and accounting changes forced employers to account for retiree medical benefits, said Larry Hicks, a Chicago-based benefits consultant at Hay Group. The life insurance programs allowed companies to set aside pools of capital to pay for employee benefits, with gains piling up tax-free.

Regulators backed the use of BOLI because it allowed banks to boost capital and risk less than they would by making loans, said Edwin Peacock Jr., owner of an insurance agency in Charlotte, North Carolina, who sold BOLI policies.

``When the Office of the Comptroller approved BOLI, it was considered the full employment act for life insurance salesmen,'' he said.

To increase life insurance returns, Fifth Third put $612 million into policies sold by Transamerica Life Insurance Corp. in 2004 and 2005.

`Stable Value'

Transamerica invested Fifth Third's insurance premiums in Citigroup's Falcon funds, according to an April 18 lawsuit. Fifth Third has sued Transamerica and its BOLI adviser, Clark Consulting Corp., to recover $323 million of losses. Transamerica and Clark Consulting are units of insure Aegon NV in The Hague.

Fifth Third bought protection from the possibility its investments would decline -- insurance on its insurance, so to speak -- in the form of a ``stable value agreement.''

Under the pact, arranged by Transamerica, Bank of America Corp. promised to cover a decline of up to 10 percent of the amount invested by Fifth Third, according to Fifth Third's lawsuit. By mid-2006, the decline was close enough to 10 percent for Fifth Third to ask Transamerica to move the money into a less risky investment.

Instead, Transamerica and Clark Consulting struck a new agreement with Bank of America that increased Fifth Third's protection to cover a decline of up to 15 percent. The bank ``reluctantly agreed,'' according to the lawsuit.

`Complete Turnabout'

Falcon kept sliding, prompting Fifth Third to strike yet another stable-value agreement in August 2007, according to the suit. This time, Fifth Third would be protected from a decline of up to 20 percent.

A month later, Fifth Third told Transamerica to enforce the latest pact. Transamerica, ``in a complete turnabout'' said the previous agreements didn't provide protection for more than a 15 percent decline, according to the suit.

As Falcon continued to decline, Fifth Third took a $155 million writedown in the fourth quarter last year. The spread between the policies' book value and current market value now exceeds $323 million, the bank said in the lawsuit. That's the minimum amount of damages Fifth Third is now seeking.

Cindy Nodorft, a spokeswoman for Transamerica and Clark Consulting, said Fifth Third was free to choose from a number of investment alternatives.

`Without Merit'

``We are confident the terms of the policy were adhered to,'' Nodorft said. ``As a result, we believe the complaint is without merit and intend to fully defend it.''

Wachovia's BOLI loss was due to the Falcon funds, company spokeswoman Christy Phillips Brown said today.

New York-based Citigroup, the biggest U.S. bank by assets, has asked Falcon investors to refrain from filing lawsuits in exchange for 45 cents on the dollar to cash out of the funds.

``As with many other credit-based investment products, the Falcon's returns have been hurt by one of the most volatile periods for fixed income in recent memory,'' said Citigroup spokeswoman Danielle Romero-Apsilos.

To contact the reporter on this story: David Mildenberg in Charlotte at dmildenberg@bloomberg.net

Last Updated: May 20, 2008 10:52 EDT