As we’ve said repeatedly, despite bank executives braying about the need to be bigger to compete or to gain efficiencies, the evidence runs completely the other way. Every study on bank efficiency in the US has found that once banks hit a certain size level (the most commonly found one seems to be ~$5 billion in assets) banks exhibit a slightly positive cost curve, which means they are more, not less, costly to run. Any economies of scale are probably offset by diseconomies of scope.
So why do bank executives sell and act on a patently phony story? Aside from the fact that doing deals is much more fun than managing a business, the BIG reason is CEO pay is highly correlated with the size of the bank, measured in total assets.
So no one should cry at the prospect that Bank of America might have to shrink to if it continues to be in financial and litigation hot water. Those of you who have been in the financial services industry will recall that it was built out of mergers of large regional banks: NCNB (North Carolina National Bank, later Nationsbank) ate First Union, Bank of America, Fleet, and of course, Countrywide and Merrill.
The Wall Street Journal has gotten some details about “emergency moves” the Charlotte bank would take if it condition worsens. This is not its Dodd Frank mandated “living will” but apparently a set of plans prepared at the request of the Fed. Bank of America is on a short leash known as a memorandum of understanding, which is accompanied by more intrusive oversight.
What is striking is that it did not contemplate a sale or spinoff of Merrill Lynch, which is the operation which makes it most difficult to resolve. Instead, it would issue a tracking stock as a way to raise money.
In other words, even for a bank developing scenarios on how to cope with serious financial trouble, the priority is to raise dough quickly rather than reconfigure the business into something tidier. Even if still not TBTF, it would be less costly to rescue. But, predictably, the priorities of management and their enablers, the regulators, is to prefer quick fixes to badly needed surgery.
Notice that a Countrywide bankruptcy was apparently not included as an option.
From the Wall Street Journal:
Bank of America Corp. has told U.S. regulators that it is willing to retreat from some parts of the country if its financial problems deepen, according to people familiar with the situation….
Bank of America Chief Executive Brian Moynihan put a possible geographic retrenchment on the list submitted in the middle of last year to Fed officials. Also on the list is a potential sale of a separate class of shares tied to the performance of Merrill Lynch & Co., the securities firm owned by Bank of America, according to people familiar with the matter. Merrill was sinking when Bank of America swooped in to buy the firm in 2008, but has since turned itself around. The Fed, which acts as the company’s primary regulator, asked for documentation about contingency plans last year in response to uncertainty about a U.S. recovery and the downward swing in Bank of America’s share price.
The drastic moves would be seriously considered only if Bank of America needs to raise more capital to cushion itself from mortgage woes and other turmoil. The exercise wasn’t intended to force immediate action but rather to prepare Bank of America if its situation worsened, according to a person familiar with the Fed’s approach….
The bank still is operating under a secret U.S. sanction known as a memorandum of understanding, which puts the bank under stricter oversight, despite steps taken by Mr. Moynihan to consolidate risk controls and shed assets. Regulators have warned the board that the sanction could escalate to a more formal, public enforcement action if they aren’t satisfied with the results of the ongoing shake-up.
The article also devotes a surprising amount of space to CEO Brian Moynihan’s leadership. Needless to say, it portrays him as struggling. This sort of account would normally be a sign that he was on his way out, and the story suggests the board would be rid of him if they thought it could find a better replacement:
Another person familiar with the board’s recent discussions about Mr. Moynihan said they are working hard to help him improve his performance. “Who else is going to run the ship?” this person said. “That’s a dilemma.”
As a mortgage investor said to me, “Can you imagine what it’s like being C level at Bank of America? It’s like being in the brace position on an airplane running on one engine.”
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Just remember that the reality is 10x worse than the whispers.
Good piece.
If any major US bank goes, it’s BoA. Seems like the obvious choice politically given its real financial position (not that others aren’t nearly as bad) but now as importantly, its toxic public profile. But as this Fed direction was during the summer, I’m not sure it wasn’t more aimed at pushing BoA to keep its eye on the ball in the context of a possible European contagion. Their share price, for what it’s worth, has recovered somewhat, and the Admin is doing everything it can think of NOT to make banks eat much of anything that looks like a loss. Also, the prospect of a big bank bust would almost certainly mean an instant Fed intervention – or pre-emptive intervention. It would be awfully difficult to claim another “Oops” a la Lehman, so I think at this point it’s not a question of a ticking time bomb so much as an exercise in Ultimate Elasticity and a very slow dismantling of BoA, with the Government getting the keep the dead parts.
Re financial services economies of scale: Isn’t the working assumption at the biggest banks still that, though more costly to operate, size gives them greater scope for BS profits? If 3 thieves cost more to feed than 2, but the third one knows what’s in the safe isn’t it still more than worth it to pour another glass? Now, at 350,000 neck ornaments, BoA’s size is mind-boggling – if they had to run an honest shop with real rules.
The one place where there are really big economies of scale are in trading and capital markets businesses. Big network effects (information advantages), plus some scale economies in infrastructure, namely IT and back office if you run them well. Also major economies of scope: it helps to be in lot of products on the institutional side (for instance, M&A + private placements + junk bonds + real estate + stock and bond underwriting).
But this isn’t at all true on the retail banking and commercial banking side. The theoretical advantages (cost savings via higher transaction processing volumes, cheaper wholesale funding) don’t seem to be as large as anticipated, and people just don’t grok that centralized, multi-layer, score based lending is more costly all in than in branch, locally based assessment.
Thanks, and agree. I suppose at the time it looked like enhanced power via sheer size and just the deals themselves were so lucrative for so many that the adrenalin just could not be throttled back. Plus the implicit backstop it appears they all had in back of mind didn’t hurt.
Is it possible that TBTF institutions are also Too Big to Manage (TBTM)? Another reason to break up several diverse business models, not just banks. (GE comes to mind. Will their dividend ever recover without divesting GE Capital?)
You can’t serve two masters (Brandeis). Managing public money and private money (shadow banking near money) are different masters.
What is money? Bankers vs. Broker-Dealers
http://www.hblr.org/download/HBLR_1_1/Ricks-Regulating_Money_Creation.pdf
Shadow Banking
http://www.ny.frb.org/research/staff_reports/sr458.pdf
BofA may become the sacrificial TBTF for this round or it may be the tipping point that when combined with the Spring Occupy resurgence will bring real change to the world of finance.
Ha!
“…so much as an exercise in Ultimate Elasticity and a very slow dismantling of BoA, with the Government getting the keep the dead parts. ”
Isn’t this what LBO artists – sorry, “Private Equity capitalists” of the Bain ilk specialize in? ‘Cept in their case, the workers and the former shareholders lose, but the government doesn’t get stuck with the whole can.
Sounds more like a threat, and a way to get people to support Bank America for fear of removing credit availability from parts of the country. why are they talking about cutting branches and not getting out of syndicated loans?
The idea is to shrink the bank by shedding deposits. By doing this geographically, they can interest regional banks.
That’s the theory, at least. But when a bank has as many consumer products tied to customer deposits as BoA does, it may not be so easy — or at a premium BoA would accept without a gun to its pointy little head.
If the deposit base shrinks dramatically (bear in mind BoA has $1.1 trillion of deposits), the bank could be forced out of some of its creative credit escapades, unless the money markets are willing to fund it and the bank regulators agree to a mismatched book (short term funding of long dated assets).
Well the depositors are a liability against assets they don’t have(at least if they marked to market)
The threat of regional withdrawal – along with the recent transfer of significant liabilities from Merrill to the FDIC-insured bank – begins to look like a mob-style chess game with regulators.
You can imagine hypothetical conversations within the bank along the line of “It would be a shame if something were to happen to FDIC and regional economies…” I hope I’m wrong about this theory.
What I love about the WSJ story is the pretense that the BofA Board is somehow in control. Every giant public company Board is a collection of stooges and pardoned turkeys: retired generals, admirals, defrocked congressmen, senile executives out to pasture, designated females and minority pinups. They snooze through a monthly power lunch, pocket stock and options in the chump change category, exchange secret handshakes and rubber stamp executive theft. They eek out a living by identical service on multiple Boards, which makes them completely beholden to CEO favor. Board Management is a more absurd oxymoronic fandango even than Government Regulation or Congressional Oversight or Public Education or Responsible Journalism. When you think about it, our entire social fabric survives (barely) on pretense covered up by magical thinking.
This morning I watched CNBC’s circus of reporter savants drool over a pastured out former celebrity CEO whose only credential seems to be having presided over the collapse of one of our most well known industrial catastrophes. Because the mute button was engaged I initially mistook her for an editor of Glamour Magazine. With the sound on she delivered the predictable snipe at ‘uncertainty over government regulation’ as an all purpose excuse for corporate non performance. You simply cannot make this shit up and produce anything more ridiculous or grotesque than reality. I have abandoned the effort to fictionalize it.
Amen! Board members simply cannot get a good sense of the company.
“stooges and pardoned turkeys”
fantastic !!!
“eek out a living”
“eke out a living” Your way is only right if they acknowledge what they’re really doing.
Since James Joyce there are no spelling errors — only unintended meanings.
If not the best post I’ve ever read, it’s in the top 5…
I work at said company. The disorganization is beyond belief. Communication between departments is non existant. The company is begging to fail.
Guess what Yves? Partial funds accounts are exploding as folks make trial payments on modification that never will become permanant!
Thank you Obama for “financial reform”!
Please tell us what are “partial funds accounts”? How are they supposed to work? What makes them “expode”?
I worked over the summer at a legal nonprofit and dealt extensively with BOA’s mortgage team — including explaining their accounting to them. I had the feeling that the folks hired to work with the nonprofits were hired because they couldn’t do math.
Mortgage servicers only need to apply a mortgage payment if it is a full one-month payment. The partial accounts are where the mortgage payment accounting system puts a partial payment. Payments on temporary modifications are partial payments that get dumped in the partial accounts. They should be posted to the mortgage as soon as there is enough to cover a full one-month payment, but only well-organized servicers manage the system correctly. It is common for full payments to have fees illegally deducted and the remainder posted to the partial account.
Too many people have authority to move money around in mortgage accounts without tracking why or where the money is being moved. Imagine trying to fix the errors in a computer program which was written with no comments — it’s close to impossible and usually more efficient to just rewrite the whole program. Essentially the mortgage servicers (esp. BoA) have an accounting system built with almost no internal controls. I have seen cases where payments were lost and the accounting is such a mess that the bank can run you around in circles claiming that they were actually posted — this actually amounts to a claim by the bank that the same $1000 entry counts for the posting of two separate $1000 checks.
Absolutely outrageous and BoA is one the worst.
Thanks for a great explanation of mortgage servicer accounting. It boggles my mind that agreed upon payments under temporary modifications are not being posted but rather placed in partial account. If a modification agreement is in effect then the partial payment is the amount that should be posted. That’s a lawsuit waiting to happen on both ends against the servicer. Full payments with fees illegally deducted and then placed in partial accounts rather than being applied sounds equally actionable.
Isnt BofA using LPS for posting payments, etc? Is it LPS or BofA that is screwed up here?
BofA will not fail this year–not with the Dem Nat Party convention coming to Charlotte this summer. Maybe in 2013, though. BofA and Citibank seem to be the dumping ground of crap financial assets with the govt’s assent.
Sorry your work situation is so bad. Start looking!
I received notice today that, as of April, my medical insurance provider is switching its HSA administrator to B of A. The air of decay emanating from B of A seems not to be of concern to them. They’re just relying on the feds too-big-to-fail promise.
I’m a BofA employee as well.
***As a mortgage investor said to me, “Can you imagine what it’s like being C level at Bank of America? It’s like being in the brace position on an airplane running on one engine.”***
Rest assured that the executives are well-compensated, well pensioned, and engaging the same non-sensical Business-School speak (BS speak), they always have…Appearing accountable and honest, while simultaneously insulated from the real consequences of their decision-making. Whether or not this is good is a personal judgment.
It’s the production-level employees who are taking the pain, particularly in the mortgage side of the business. Workforces have been cut ~40%, while pipelines have increased ~200%. Benefits? Cut and the cost to the employee increased. Bonusses? So small they may as well be non-existent. Remember back in August of 2009 when the administration wanted to cap executive compensation for TARP participants? Remember how quickly those TARP funds got repaid? Where do you think the money came from? I’ll tell you–it came out of the paychecks of ordinary employees. Executive compensation was preserved.
Afraid at B of A is right when he says interdepartmental communication is non-existent. Disorganization reigns. Supposedly executive-level decisions are routinely reversed from executives in parallel offices, often on the same day they were issued. There are many instances of the same address in the foreclosure, shortsale, and modification pipelines, with work proceeding in each. Efficiency? Economy of scale? I have yet to see it.
The company’s real goal is to reduce it’s mortgage position and increase it’s position in international finance through it’s Merrill holding. Based on what I’ve seen, this may be the only viable opion. At this point, at least.
Hope to read more posts from you under the same name.
Slight correction:
First Union was not acquired by Nations Bank/BoA. First Union acquired Wachovia and took its name as part of the deal with regulators before being acquired by Wells Fargo.
I understand that BOA is now foreclosing under the names of over 285 different entities. What is that about? In Kemp v. Countrywide (NJ) the Countrywide VP of 13 years stated that “we never deposited the notes into the trusts. We filed them”, to which BOA/CW counsel retorted, “she doesn’t know what she’s talking about”. After 13 years as head of the docment control department she doesn’t know what she’s talking about? What’s going on here?
Bank of America is also foreclosing under the names of entities that *do not exist* and judges on autopilot are granting foreclosures without reading the controls. If an entity doesn’t exist then it cannot file suit to foreclose.
A point of clarification. Isn’t the maximum efficient asset size $50 billion for banks, or at least bank holding companies? Here’s a list of BHC. Note that you have to go to position 35 before you hit the $50 billion limit.
http://www.ffiec.gov/nicpubweb/nicweb/top50form.aspx
The BOA branch in Barboursville, WV has already changed over to a local regional bank, if that is an indication of anything.
The BOA up here in Maine is closing too. What a shame.
Mergers on a good day create 5 years of chaos. Mergers in a crisis where systems don’t communicate or don’t exist will prolong the chaos. If there are splits, split based on systems.