Bank of America's (BAC) Egregious Error May Put it Back in Fed's 'Penalty Box'

Just when Bank of America (NYSE: BAC) investors thought the company was out of the woods and could get back to business as usual it announced a major accounting flap that moved the Fed to halt the company's recently announced capital return plan, leaving shareholders reeling.

Shares of Bank of America are down over 5% Monday after the company announced this morning that is has suspending its capital actions amid an error in its Basel 3 capital calculation that overstated its capital ratios. The error was related to an incorrect adjustment being applied in the determination of regulatory capital related to the application of the fair value option to certain legacy Merrill Lynch structured notes. As a result of the error, the company made the following adjustments to the previously announced estimated preliminary capital ratios for the first quarter ended March 31, 2014: the estimated Basel 3 Standardized transition common equity tier 1 capital ratio was revised to 11.8 percent, down 5 basis points; the estimated tier 1 capital ratio was revised to 11.9 percent, down 21 basis points; the estimated total capital ratio was revised to 14.8 percent, down 21 basis points; and the estimated tier 1 leverage ratio was revised to 7.4 percent, down 12 basis points.

Bank of America promptly notified the Federal Reserve Board (FRB) of the revisions and at the FRB’s request, the company is suspending its previously announced 2014 capital actions, including the $4.0 billion common stock repurchase authorization and the planned increase in the quarterly common stock dividend from $0.01 per common share to $0.05 per share.

The news has several negative implications, according to Evercore Partners analyst Andrew Marquardt. He highlighted: 1) lower buybacks will hurt fwd EPS ests by $0.03-0.04/shr annually (2-3%); 2) may pressure expenses; and, 3) potentially back in the “penalty box” from Fed’s perspective given this issue follows BAC needing to use the mulligan in ’14 CCAR process where lowered payout ask (recall we long warned that BAC had little wiggle room based on our CCAR work). And, lastly, such a good reminder of the power of the Fed in terms of ability to pull capital deployment actions swiftly as well as likely re-highlights broader questions of too-big-to-manage for such universal banks, when/if we get more meaningful capital deployment for industry (which we’ve been skeptical of any time soon in part due to pending CECL and rising rate implications of AOCI), and internal control/compliance focus by regulators and mgmt teams (now both BAC and Citi potentially back in penalty box following and despite prior seemingly rigorous focus on such as both failed CCAR in the past).

When excluding the impact of the entire $4 billion stock buyback, Marquardt's FY 2014 estimates would go down to $1.26 (from $1.27), FY 2015 to $1.53 (from $1.56), and FY 2016 to $1.69 (from $1.73).

Elaborating further on BofA being back in the Fed's “penalty box”, the analyst said: the calualation error could raise additional questions around adequacy of internal controls/modeling, etc. and error/restatement reduced B3 capital (-$0.7b for T1C and -$2.7b for T1 & Total cap). The analyst also recalls that Bank of America already needed to use the mulligan in ’14 CCAR having to lower its payout ask. Despite the error though the analyst is maintaining an Overweight rating and $18 price target on the stock.

Shares of Bank of America last traded at $15.07, down 5.5%.

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