BofA Needs $50 Billion Cushion as Mortgage Expenses Swell
Bank of America Corp. (BAC) may have to build its capital cushion by $50 billion and renege again on Chief Executive Officer Brian T. Moynihan’s pledge to raise the firm’s dividend as mortgage losses drain funds.
Expenses tied to soured home loans may total $20.4 billion in the second quarter, pulling the bank further from capital ratios demanded under new international standards, the Charlotte, North Carolina-based company said June 29. The gap may equal 2.75 percent of risk-weighted assets starting in 2013 -- at about $18 billion for each percentage point -- crimping Moynihan’s ability to raise dividends and repurchase shares.
“They are likely to be in capital-building mode for longer than previously anticipated,” Jason Goldberg, a Barclays Capital analyst, said in an interview. For now, he said, “I’m hard-pressed to see meaningful capital redeployment.”
Moynihan, 51, has booked about $30 billion in settlements and writedowns to clean up mortgage liabilities at the biggest U.S. bank since succeeding Kenneth D. Lewis last year. As the costs mounted, Bank of America’s stock declined 27 percent this year, the worst showing in the 24-company KBW Bank Index. The company reports second-quarter results tomorrow and has told investors to brace for a loss of as much as $9.1 billion.
“The charges have had the effect of reducing mortgage uncertainty but have pushed dividend increases further into the future,” Richard Staite, an analyst with Atlantic Equities LLC, said in a June 30 note. Staite and Goldberg both estimate that Bank of America needs to raise $50 billion to comply with the new capital requirements, designed to build a buffer against losses and avert a repeat of the 2008 financial crisis.
Under rules prepared by the Basel Committee on Banking Supervision, Moynihan has to achieve a 9.5 percent ratio of capital to risk-weighted assets between 2013 and 2019. That’s based on a 7 percent minimum and a 2.5 percent surcharge imposed by regulators on the largest companies whose collapse would pose a threat to the banking system.
Moynihan’s task was complicated after he underestimated how big the capital surcharge would be. The bank counted on 1 percentage point, an assumption based upon “fairly senior information saying that was a reasonable number to use,” Moynihan said in a June 1 conference. The 2.5 percent announced last month means an extra $27 billion burden.
“It’s phased in over time, so there’s time to meet the requirement,” said Jerry Dubrowski, a Bank of America spokesman. “On the dividend, we know we have some work to do relative to the capital plan, and when we complete that work we’ll resubmit it to the Federal Reserve.”
Bank of America fell 28 cents, or 2.8 percent, to $9.72 in 4 p.m. New York Stock Exchange composite trading. That’s the lowest since May 2009, when the company still held $45 billion in U.S. bailout funds to help it survive the global financial crisis.
Moynihan has previously had to revise guidance about the bank’s dividend after the Fed rejected what he called a “modest” increase requested for later this year. His deals to settle disputes over defective mortgages, including an $8.5 billion accord last month, means the CEO may have to adjust another promise to investors -- a larger dividend boost by 2013.
In March, Moynihan said that all $42 billion of projected earnings in 2013 and 2014 would be returned to shareholders. Bank of America was “committed” to raising its 1-cent dividend to a higher level equal to 30 percent of earnings, he said.
“We go from being a company which gets its capital in shape in 2011 and 2012 and pays a modest dividend to a company which has significant capital generation from there on out,” Moynihan said at the March 8 conference. The result would be a total of $12 billion in payouts during those two years, he said.
That plan may be stymied as Moynihan writes checks to settle disputes inherited from the 2008 takeover of subprime lender Countrywide Financial Corp., whose lax underwriting led to soaring defaults on mortgages and claims from investors who bought or insured them. He announced a $3 billion accord with Fannie Mae and Freddie Mac in January, a $1.6 billion deal with bond insurer Assured Guaranty Ltd. in April and the $8.5 billion settlement with institutional investors last month.
With the costs climbing, Bank of America last month cut its 2013 forecast of its capital ratios under the new rules to 6.75 percent to 7 percent, from 8 percent in April. That estimate is based on the premise that the rules are fully enforced in 2013.
Executives and analysts expect the rules will be phased in over several years, making it less likely that Bank of America will be left short on capital and be forced to sell new shares. The added time would allow the bank to reach its goals by retaining earnings or getting rid of riskier assets that require a lender to hold more capital to cushion losses.
China Construction Stake
The bank is weighing the sale of at least part of its $21 billion stake in China Construction Bank Corp., three people briefed on the plans said last month. The sale would simultaneously raise cash and reduce assets that are penalized under the capital rules.
Bank of America, which under Basel rules may be labeled a systemically important financial institution, or SIFI, expects to have $1.8 trillion in risk-weighted assets by 2013 and said it intends to reduce that figure to ease capital needs. To meet the 9.5 percent standard, the bank would have to hold about $171 billion in capital. That compares with $122 billion for the 6.75 percent ratio.
The bank will “take a hard look at our balance sheet and the businesses that we were in if, with the SIFI, you were up at 9.5 percent,” former Chief Financial Officer Charles Noski said in March. He was replaced by Bruce Thompson last month.
The bank’s lower capital goal for 2013 may signal the company expects to earn less than it did just a few months earlier as the U.S. economy slows, said Goldberg, who has the equivalent of a “hold” recommendation. Chris Kotowski, an Oppenheimer & Co. analyst, didn’t rule out a share sale in his June 30 research note.
“Bank of America’s capital position relative to peers creates dilution risk,” wrote Kotowski, who has a “market perform” recommendation on the lender. “While we aren’t certain that an equity raise will actually happen, the risk is certainly there.”
The lender may have to hoard cash until 2016 to reach the 9.5 percent capital goal, about three years behind rivals including JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC), Kotowski said, even while those firms raise payouts and buy back shares.
Moynihan has said at least twice this year that the firm won’t need to issue common stock to meet the new capital threshold. Regulatory capital under existing international rules has steadily improved in the past two years, the company said last month.
The lender still faces more mortgage-related costs that may sap capital. The five largest servicers may pay more than $20 billion to settle probes by the U.S. Department of Justice and 50 state attorneys general over shoddy mortgage servicing practices, said two people briefed on the matter.
Bank of America may also have another $5 billion in costs tied to repurchase demands from institutional investors and could face other expenses related to securities and fraud allegations on soured Countrywide loans, the company said. Further, if U.S. home prices decline beyond internal company estimates, the bank may need to set aside more for bad mortgages purchased by Fannie Mae, executives have said.
“Will the charges this quarter for all these mortgage settlements kind of be the end of it?,” said Anton Schutz, the president of Mendon Capital Advisors Corp., an asset manager that specializes in the stocks of financial-services companies and owns Bank of America shares. “If it is, they can build capital really quickly. There’s the constant fear that they need to raise capital, which I disagree with.”
To contact the reporters on this story: Hugh Son in New York at email@example.com