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BAC Bank of America Corp
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BAC Bank of America Corp

  #11 (permalink)
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From ZH...thought I saw something on this

Bank of America, which today reported a big bottom line loss net of one-time beneficial items, did something quite tricky and extremely devious last month: it shifted anywhere up to the total of $53 trillion of the total derivatives it held as of June 30 (as Zero Hedge previously reported) on its books at Q2 from the Holding Company, which was downgraded last by Moody's from A2 to Baa1 (the third-lowest investment grade rating) to its retail bank, which was downgraded to the far more palatable A2 (from Aa3). The reason for the transfer? Bank customers who were uneasy with the fact that suddenly the collateral backstoping the operating entity handling their counterparty risk was downgraded to just above junk, demanded that said counterparty risk be mitigated by the bank's $1 trillon in deposits. In other words, as Bloomberg first reported when it broke this story, anywhere up to the full $53 trillion (we don't know for sure how much so we assume the worst case) is now fully and effectively backstopped explicitly by the bank's $1,041 trillion (as of September 30) deposits. Pardon's we meant the people's deposits: the same deposits which caused the bank's website to be inoperative for several days in a row after it was rumored that there was an electronic run on the bank. Why? Just so Bank of America can appears whatever remaining clients it has so they decide not to take their business to another derivative counterparty. And who is exposed to this latest idiocy? Why you. But that's not all: the FDIC, which is the entity backstopping the deposits in a worst-case scenario, is not happy with this move for obvious reasons. Yet even it is hopeless to override the Fed, which as Bloomberg reports, "has signaled that it favors moving the derivatives to give relief to the bank holding company." And so, once again, we see just how much more important to the Federal Reserve are interests of US taxpayers and savers, over those of the banks that effectively run the Fed.
Bloomberg reports:
Bank of America Corp. (BAC), hit by a credit downgrade last month, has moved derivatives from its Merrill Lynch unit to a subsidiary flush with insured deposits, according to people with direct knowledge of the situation.

The Federal Reserve and Federal Deposit Insurance Corp. disagree over the transfers, which are being requested by counterparties, said the people, who asked to remain anonymous because they weren’t authorized to speak publicly. The Fed has signaled that it favors moving the derivatives to give relief to the bank holding company, while the FDIC, which would have to pay off depositors in the event of a bank failure, is objecting, said the people. The bank doesn’t believe regulatory approval is needed, said people with knowledge of its position.

Jerry Dubrowski, a spokesman for Charlotte, North Carolina- based Bank of America, declined to comment on the transfers or the firm’s discussions with regulators. The company “continues to accommodate the needs of our clients through each of our multiple trading entities, including Bank of America NA,” he said in an e-mailed statement, referring to the company’s deposit-taking unit.

Barbara Hagenbaugh, a Fed spokeswoman, said she couldn’t discuss supervision of specific institutions. Greg Hernandez, an FDIC spokesman, declined to comment.
The catalyst: the Moody's downgrade of the bank to a rating far more indicative of BAC's insolvent (aka D) status:
Moody’s Investors Service downgraded Bank of America’s long-term credit ratings Sept. 21, cutting both the holding company and the retail bank two notches apiece. The holding company fell to Baa1, the third-lowest investment-grade rank, from A2, while the retail bank declined to A2 from Aa3.

The Moody’s downgrade spurred some of Merrill’s partners to ask that contracts be moved to the retail unit, which has a higher credit rating, according to people familiar with the transactions. Transferring derivatives also can help the parent company minimize the collateral it must post on contracts and the potential costs to terminate trades after Moody’s decision, said a person familiar with the matter.
"All perfectly normal"
The moves by Bank of America are part of “the normal course of dealings that we’ve had with counterparties since Merrill Lynch and BofA came together,” Thompson said today.
Moving derivatives contracts between units of a bank holding company is limited under Section 23A of the Federal Reserve Act, which is designed to prevent a lender’s affiliates from benefiting from its federal subsidy and to protect the bank from excessive risk originating at the non-bank affiliate, said Saule T. Omarova, a law professor at the University of North Carolina at Chapel Hill School of Law.
With the Fed's blessing:
Moving derivatives contracts between units of a bank holding company is limited under Section 23A of the Federal Reserve Act, which is designed to prevent a lender’s affiliates from benefiting from its federal subsidy and to protect the bank from excessive risk originating at the non-bank affiliate, said Saule T. Omarova, a law professor at the University of North Carolina at Chapel Hill School of Law.

In 2009, the Fed granted Section 23A exemptions to the banking arms of Ally Financial Inc., HSBC Holdings Plc, Fifth Third Bancorp, ING Groep NV, General Electric Co., Northern Trust Corp., CIT Group Inc., Morgan Stanley and Goldman Sachs Group Inc., among others, according to letters posted on the Fed’s website.

The central bank terminated exemptions last year for retail-banking units of JPMorgan, Citigroup, Barclays Plc, Royal Bank of Scotland Plc and Deutsche Bank AG. The Fed also ended an exemption for Bank of America in March 2010 and in September of that year approved a new one.

Section 23A “is among the most important tools that U.S. bank regulators have to protect the safety and soundness of U.S. banks,” Scott Alvarez, the Fed’s general counsel, told Congress in March 2008.
In other words, while previously there had been a firewall between the bank's depository entity and the one that gambles, on either a flow or prop basis, with the abovementioned multi-trillion number, that firewall is now gone and all the money has been comminlged, explaining the FDIC's fear. And of course, in order to thank depositors for being explicit guarantors of the bank's derivative business, it is now forcing them to pay a $5/month fee.
Somehow we really doubt the 12/31 update will show a "total deposits" number over $1 trillion. Or anywhere remotely close.
Laslty, nobody should make the mistake that BofA is alone in this move: every other bank that has major derivative exposure and has a depository base has certainly been forced to do precisely the same by its bigger accounts, who have no desire of being exposed to surging counterparty risk and would much rather split it with America's depositors.

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I'm trying to understand what this would look like. If the bank continues to lose money on these derivatives, and then we see a collapse of BAC, what are we looking at here? FDIC? But isn't it more complicated, specifically for accounts >250k, because the argument would be the assets were safe up until the moment the bank chose to apply them to derivatives...

Still trying to understand the implications.

Mike

With regards to the FDIC and the amount in which they will insure is up to $250k per SS# and/or tax ID#. Anything beyond that is uninsured. BAC has roughly $1 trillion in deposits which is made up of commercial/business deposits and consumer deposits. If BAC were to fail, the Deposit Insurance Fund which is held by the FDIC does not even come close to covering this. The FDIC can borrow another $500 billion to provide additional coverage but even then, they may fall short. This is why there would be some sort of forced TARP situation again.

The right thing to do here is demand that BAC move those derivatives back to where they were. If they can't, then clearly they're insolvent and should be dismantled immediately. It will certainly cause a disruption in the markets but this should have been taken care of in 2008. Citi is certainly next on this list.

I think the US is going to have a tough pill to swallow in the next few years. We're going to have to make some tough decisions and it will be ugly in the near term but far better in the long term. It's the only way out of this mess IMO.

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Not to sound over-dramatic, but do you really see that happening? In an election year no less!

I have lost faith in our government to force any pill swallowing. It is all bury your head and see where you come up later!

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More info and commentary

Bank of America Deathwatch: Moves Risky Derivatives from Holding Company to Taxpayer-Backstopped Depositors naked capitalism

The Fed has pissed off the FDIC with this doozy.

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bluemele View Post
Not to sound over-dramatic, but do you really see that happening? In an election year no less!

I have lost faith in our government to force any pill swallowing. It is all bury your head and see where you come up later!

I guess the better question is why would BAC do such a dramatic move? I can definitely see things falling apart and the government will feel they have to do some sort of bailout in an attempt to save their votes. So because it's an election year, yes. Do I really see this happening? It's very possible. The derivatives market will blow up, it's just a matter of when. No one saw Lehman or Bear but by watching their stock price and CDS it was obvious what was happening. BAC's stock is still hovering at it's low while it's CDS is the highest of the TBTF's I believe. Those are just my observations of course.

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I guess the better question is why would BAC do such a dramatic move? I can definitely see things falling apart and the government will feel they have to do some sort of bailout in an attempt to save their votes. So because it's an election year, yes. Do I really see this happening? It's very possible. The derivatives market will blow up, it's just a matter of when. No one saw Lehman or Bear but by watching their stock price and CDS it was obvious what was happening. BAC's stock is still hovering at it's low while it's CDS is the highest of the TBTF's I believe. Those are just my observations of course.

Why will the derivatives market blow up? What is a given? I guess I don't understand why this is a foregone conclusion?

Which derivatives , specially CDS? Or the CMBS, RMBS packages are taking them down or what? I guess I don't watch the news so... Please explain why it is a given that these CDS or whatever are going to come due. Not saying I don't believe you, but just curious.

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bluemele View Post
Why will the derivatives market blow up? What is a given? I guess I don't understand why this is a foregone conclusion?

Which derivatives , specially CDS? Or the CMBS, RMBS packages are taking them down or what? I guess I don't watch the news so... Please explain why it is a given that these CDS or whatever are going to come due. Not saying I don't believe you, but just curious.

No worries, I'm very selective with what news sources I read as well. The derivatives in which I'm referring to are Collateralized Debt Obligation (CDO's), and Credit Linked Notes (CLN's) which are cash settled via Credit Default Swaps (CDS). CDO's and CLN's are packed RMBS and CMBS along with other Asset Backed Securities (ABS) that placed into multiple tranches based on credit quality, etc. within each CDO/CLN. CDS serve as insurance against a default in these securities such as missing a payment, etc. The issue arises when money has to change hands. Does the insurer have the funds to cover this giant market? Think of a put buyer and a put seller. Remember AIG? It's obviously a lot more complicated than what I've explained here but that's the gist of it.

So I think these will blow up because of the growing default/credit risk with the further deterioration of the bank's balance sheets. As bank's balance sheets deteriorate there capital is crunched yet they still have far more outlying obligations than what they claim on there balance sheets via CDS exposure. If there is a massive credit event (loan defaults within CDO's/CLN's) an undercapitalized bank will be required to settle a CDS, they most likely won't be able to meet those obligations. It's essentially one big domino effect. Case in point the banks in Europe right now and there need to be recapitalized. I can guarantee US banks have CDS exposure to the EU banks. It just takes one catalyst event.

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No worries, I'm very selective with what news sources I read as well. The derivatives in which I'm referring to are Collateralized Debt Obligation (CDO's), and Credit Linked Notes (CLN's) which are cash settled via Credit Default Swaps (CDS). CDO's and CLN's are packed RMBS and CMBS along with other Asset Backed Securities (ABS) that placed into multiple tranches based on credit quality, etc. within each CDO/CLN. CDS serve as insurance against a default in these securities such as missing a payment, etc. The issue arises when money has to change hands. Does the insurer have the funds to cover this giant market? Think of a put buyer and a put seller. Remember AIG? It's obviously a lot more complicated than what I've explained here but that's the gist of it.

So I think these will blow up because of the growing default/credit risk with the further deterioration of the bank's balance sheets. As bank's balance sheets deteriorate there capital is crunched yet they still have far more outlying obligations than what they claim on there balance sheets via CDS exposure. If there is a massive credit event (loan defaults within CDO's/CLN's) an undercapitalized bank will be required to settle a CDS, they most likely won't be able to meet those obligations. It's essentially one big domino effect. Case in point the banks in Europe right now and there need to be recapitalized. I can guarantee US banks have CDS exposure to the EU banks. It just takes one catalyst event.

Ok, this makes sense and some of it was new to me, but what specifically do you believe will force default into these CDO's? Is it another wave of CMBS/RMBS (seems like CMBS came in strong all at once, but unlikely to make a difference now?) and just curious on what you think the trigger will be to cause the defaults? My guess is you are referring to another wave of RMBS or some other form of ABS?

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bluemele View Post
Ok, this makes sense and some of it was new to me, but what specifically do you believe will force default into these CDO's? Is it another wave of CMBS/RMBS (seems like CMBS came in strong all at once, but unlikely to make a difference now?) and just curious on what you think the trigger will be to cause the defaults? My guess is you are referring to another wave of RMBS or some other form of ABS?

Yeah, I think as the economy gets worse we will see more and more defaults occurring. As people continue to lose their jobs or they finally just give up and walk away these factors could affect the RMBS market. With regards to the CMBS market, that's an entirely different game really. Many commercial mortgage borrowers have customized criteria and covenants they must adhere to in addition to paying their loan on time such as having liquidity maintenance agreements or some sort of capital ratio to meet which is reviewed on a quarterly, semi-annual or annual basis. It all depends on the deal I guess. But with many businesses struggling, they are failing to meet their respective loan covenants thereby creating loan pay downs requests by the lender or some sort of work out process. As this occurs, many borrowers end up defaulting entirely. I don't think it's as common as residential borrowers defaulting but it's an issue and of course, commercial loans are typically far greater in size.

But having a borrower default is just one way to trigger a credit event. There are other issues that can occur such as rating agency down grades, etc. Also, the ABX and PrimeX markets are selling off pretty hard right now signaling some serious stress in the MBS markets. Here's an interesting article from ZH discussing this issue: TimberX | ZeroHedge.

Hope this helps.
Cheers,
PB

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Ok, thanks. Being in Real Estate (Commercial & Residential) then I am always curious as to what people's perspective of the situation may be.

I have been waiting for judgement day on the commercial side, but unfortunately the commercial lenders were quick to deal with loan variances. I think the big difference is that they can pay attorney's a bit more to get in there and shake it up more quickly and you tend to be dealing with more sophisticated people who don't want to walk away as quickly.

I see the bigger risk as Sovereign, State/Municipal Bonds, etc.. I think those that have lost there houses have already done so while others are renting. I see rents rising over the next few years as interest rates go up and NOBODY can buy, which will put continued downward pressure on pricing.

Imagine trying to sell a nice 3M Kahala/Diamond Head home (2.5M in debt let's say) with a payment of 12.7K per month (4.5%) and when interest rates fall back to a more likely range of 7.5%, then you will be @ 17.5K per month.

Makes it interesting to find the same amount of available buyers. Real Estate stagflation....

I realize none of this is news to you, but boy is it going to be an interesting 10 years! (lost decade anyone?)

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