Bank of America Sent to the Woodshed, Big Time (And Citi Going There Too)

The Wall Street Journal has quite a bombshell, namely, that the Fed and the Office of the Comptroller of the Currency have ordered the Bank of America to make changes to its board and clean up its risk and liquidity management. The bank is under the shortest of regulatory short leashes, a memorandum of understanding, a virtual choke chain. It imposes deadlines for meeting specific goals over the next few months.

I’ve been complaining for some time that regulators in the US have been afraid for some time of acting like regulators and showing some steel when circumstances warranted.

While the new tough posture is welcome, it still begs the question of whether the regulators are directing their energies to the best uses, and whether changes demanded of BofA are far ranging enough, and focused at the right level of operation. It also suggests that a lot is amiss at the Charlotte bank, or perhaps at its newly acquired headache, Merrill Lynch.

An MOU is a serious sanction. Newly but probably not permanently risen-from-the-dead Citigroup has an MOU in place with the Office of the Comptroller of the Currency and is negotiating one with the OCC.

What I find most troubling is these are all measures that appear to relate to the traditional banking business. The more volatile risks sit at Merrill. Has anyone from the outside taken a good look under that hood?

Will this worrisome data point put a dent in the Meredith Whitney rally?

From the Wall Street Journal:

Bank of America Corp. is operating under a secret regulatory sanction that requires it to overhaul its board and address perceived problems with risk and liquidity management, according to people familiar with the situation.

Rarely disclosed publicly, the so-called memorandum of understanding gives banks a chance to work out their problems without the glare of outside attention. Financial institutions that fail to address deficiencies can be slapped with harsher penalties that include a publicly announced cease-and-desist order…

Bank of America faces a series of deadlines, some at the end of July and others in August, these people said.

The company might get more time to complete some of the steps it is taking, such as reconstituting its board with a majority of new directors. Since early June, Bank of America has named four directors to its 16-person board, leaving the bank considerably short of the government’s requirement….

Wider margins from trading are expected to help Bank of America show a decent profit when it reports second-quarter results Friday. But the bank still is being hammered by troubled loans and other consequences of the recession.

In late January, the Federal Reserve and Office of the Comptroller of the Currency downgraded their overall ratings of the bank to “fair” from “satisfactory,” according to people familiar with the matter. In a letter that was reviewed by The Wall Street Journal, the Fed criticized Bank of America’s management and directors for being “overly optimistic” about risk and capital. The bank’s capital position “was vulnerable” even before the Merrill deal, the Fed concluded, citing “acquisition activity” that included last year’s takeover of mortgage lender Countrywide Financial Corp.

“Management has taken on significant risk, perhaps more than anticipated at the time the acquisition was proposed,” a Fed official wrote in the letter, which accompanied the ratings downgrade and was sent days after the government agreed to $20 billion in aid to keep the Merrill deal on track. As a result, “more than normal supervisory attention will be required for the foreseeable future.”,,,

Yves here. So at a minimum, as many predicted, the Tanned One, as always, got the best end of the deal. I was mystified as to why they’d want to take on a garbage barge like Countrywide (yeah, yeah, I know, the subprime servicing and the tax bennies).

But another bit is troubling here. I seldom get the fair Ms. Whitney’s research (hint hint). The last piece I saw was about a year ago, when she went through the housing market assumptions of all the big banks. She then found BofA to be the most conservative, as in they were using the lowest values, but she still deemed them to be too high.

So the question then becomes: has BofA stood still, more or less, or taken insufficiently aggressive markdowns on Countrywide to attenuate the losses? Or is the picture of last year still valid, and the giant bank is actually showing lower marks than many of its peers, despite the MOU charge that it is being “overly optimistic?”

The two may not be inconsistent. The bank could still be fairly realistic in its asset valuations, but too optimistic re future earnings, which means it would argue it didn’t need as much capital (ie, it could earn its way out). Back to the article:

The MOU surprised some Bank of America executives who hadn’t expected federal regulators to issue such a formal rebuke. The bank responded swiftly, with six directors resigning since May 26. The departures include O. Temple Sloan Jr., Bank of America’s lead independent director, and Jackie Ward, chairman of the board’s asset-quality committee.

It is possible that regulators will allow Bank of America to count two directors who joined the board as part of the Merrill purchase to be considered “new,” according to one person familiar with the discussions. Walter Massey, president emeritus of Morehouse College, who took over as chairman from Mr. Lewis, also is leading a continuing search for additional candidates.

Late last month, Chief Risk Officer Amy Woods Brinkley stepped down in what company officials described as a retirement. J. Chandler Martin exited this week from his post as enterprise credit and market risk executive.

A spokesman confirmed that Mr. Martin, who retired in March 2008 as treasurer after 27 years at Bank of America but returned to help with the Merrill integration, is no longer with the company. Mr. Martin declined to comment.

Banks that have disclosed they are operating under a memorandum of understanding include Colonial BancGroup Inc., a regional bank based in Birmingham, Ala., and Riverview Bancorp Inc., Vancouver, Wash., which has just 18 branches.

Update: Did my early AM news sweep in the not usual order, and so just saw that Citi, which unlike Bank of America, has been in a public tussle with a regulator, in this case FDIC (Shiela Bair has wanted Pandit’s head), the Financial Times says the bank is close to a “secret deal” with the FDIC.

“Secret” and being the lead story at the FT are internally inconsistent..The pink paper seems to be slipping.

But it is a bit odd that we have two leaks of the same sort of new item in one night. The conspiracy minded will no doubt find a way to connect the dots From the Financial Times

Citigroup is close to a secret agreement with one of its main regulators that will increase scrutiny of the US bank and force it to fix financial, managerial and governance issues….

The proposed agreement requires, among other things, that Citi strengthens its board and governance, improves asset quality, better manages expenses and provides more information to regulators on its capital and liquidity, these people added.

The regulator’s action highlights concern over Citi’s financial health, governance and the strength of its management team, led by Vikram Pandit, chief executive. The FDIC is known to be frustrated with the slow pace of Citi’s “toxic” assets sales, its losses and the lack of commercial banking experience at the top.

An agreement would strengthen the FDIC’s position in its dealings with Citi and its demands for detailed financial information as it deliberates over whether to include it on its list of “problem banks”.

Citi, which is about to cede a 34 per cent stake to the US government as part of its latest rescue, struck a similar agreement with another regulator late last year, industry executives say…

Agreements between regulators and a bank’s management and board – known as “informal actions” – are not made public to avoid stoking investors’ fears. They can be in a “memorandum of understanding” or a “commitment letter” from the bank to the authorities and are fairly unusual and less serious than formal enforcement actions.

Some MOUs and commitment letters can restrict the company’s ability to operate in certain markets or products but it is unclear whether Citi’s latest agreement contains such provisions.

Citi, which is expected to report a second-quarter loss on Friday, is already addressing some of the regulators’ concerns. It has hired five new directors and is looking for three more, bolstered its balance sheet and recruited executives with commercial banking expertise. It has also pledged to sell billions of dollars in non-core businesses and assets.

The proposed agreement with the FDIC focuses on Citi’s business and governance rather than its executives and was not a direct cause for last week’s switch of its finance chief Ned Kelly to another role, said people close to the situation.