BofA error causes pull back

Apparently Bank of America Corp. is having some trouble with its books. The bank said today it would cancel its share buyback program after making an error in calculating its capital.

Here’s the story from Christina Rexrode, Dan Fitzpatrick and Ryan Tracy in the Wall Street Journal.

An apparent communications blunder inside Bank of America Corp forced the lender to shelve a plan to buy back shares and boost its dividend for the first time since 2008, another setback for Chief Executive Brian Moynihan‘s efforts to escape the long shadow of the financial crisis.

The second-largest U.S. bank by assets Monday said it discovered a mistake in certain figures submitted to the Federal Reserve for the regulator’s annual “stress tests” of major U.S. financial institutions. The error leaves the Charlotte, N.C., bank with $4 billion less in capital than it thought it had. The bank had been making the same calculation error since 2009, according to a person close to the bank.

Bank of America brought the mistake to the Fed’s attention. The regulator revoked its prior approval of a dividend increase and gave the bank until May 27 to submit a new plan. But the bank said the cash returned to investors in the new plan will be less than in the previous one.

Disappointed shareholders pushed the stock down 6.3%, to $14.95 a share, the biggest one-day plunge since 2012.

The blunder shows the difficulties executives and regulators face in overseeing financial firms that have become more complex and more sprawling since a wave of forced mergers during the financial crisis.

Writing for the New York Times, Peter Eavis and Michael Corkery led with the amount of the mistake — $4 billion.

The mistake, which had gone undetected for several years, led the bank to report recently that it had $4 billion more capital than it actually had. After Bank of America reported its error to the Federal Reserve, the regulator required the bank to suspend a share buyback and a planned increase in its quarterly dividend.

While regulators still believe Bank of America has sufficient capital, the disclosure of the accounting error will most likely add fuel to the debate over whether the nation’s largest banks are too big and complicated to manage.

The error also raises questions about the quality of Bank of America’s own accounting employees, who are supposed to present an accurate financial picture of the bank’s sprawling operations to the public and regulators each quarter. The audit committee of the bank’s board and PricewaterhouseCoopers, its external auditor, also allowed the error to slip by for so long.

“There are signs that controls are not as tight as they need to be,” said Mike Mayo, an analyst at CLSA. “It’s a bank. It needs to get the numbers right.”

The Reuters story by Peter Rudegeair and Tanya Agrawal outlined what Bank of America’s capital plan might look like after disclosing the mistake.

The announcement illustrates how difficult it is to determine appropriate capital levels for the biggest banks, particularly under hypothetical stress situations that regulators consider. Bank of America now has to submit its request to return more capital to shareholders for a third time, and the Fed itself previously erred in projecting the bank’s minimum capital ratios under a stressed scenario.

The previously approved increase in the bank’s dividend would have been the first since the financial crisis, and raising it has been a focus of top executives. Banks historically paid out relatively high dividends, spurring retirees and other investors seeing income to buy their shares.

Banks failed to cut their dividends even as their earnings shrank during the financial crisis, burning up valuable capital and leaving them more vulnerable as the housing market deteriorated. In response, lawmakers have given regulators much more control over banks’ plans to return funds to shareholders.

The Fed said Bank of America has 30 days to submit a new plan that corrects the errors and ensures no further reporting problems if it would like to return more money to shareholders over the next four quarters. (link.reuters.com/zef88v)

The bank said its new plan will likely be more modest than its prior request. In March, the bank received approval to buy back $4 billion of shares and increase its dividend payout by more than $1.5 billion a year, or 5 cents per share per quarter from 1 cent.

Kyle Stock of Bloomberg Businessweek wrote a piece about the actual mistake, which pointed out that it was mostly on paper, but still costly:

The mistake was buried in a complicated jumble of financial machinery that the bank inherited when it bought Merrill Lynch in 2009. The glitch involved structured notes, hybrid products in which an underlying debt obligation fluctuates based on something entirely separate. Imagine a loan whose payout rests on whether Facebook (FB) shares fall by 20 percent.

What’s interesting is that Bank of America did not appear to have fouled up its accounting on esoteric bets that were in play—so-called “unrealized” notes—in an error that might have been somewhat understandable. It appears the bank just overlooked a batch of these products that had run their course and ended up as a loss.

The slip-up won’t affect earnings but it will require quite a bit of expensive paper-shuffling, as the bank tries to clear its books with the Fed and get regulators to approve its stock buyback and dividend plan. All told, the correction required the bank to lower its important ratios by fractions of a percent. (Here’s the full, very dense mea culpa.) That’s a fairly big deal for a corporation with almost $1 trillion in loans outstanding.

Bank of America is back in the spotlight again for mistakes that actually seem to have more to do with paperwork and less to do with business operations. But who’s to say which is the costlier sin? Looks like investors weren’t happy with Monday’s disclosure, but much of that is likely due to the loss of capital return and less to do with a statement on management.