Bank Of America: Once More With Pain

Apr.30.14 | About: Bank of (BAC)

Summary

Bank of America announces a problem found in their regulatory accounting.

Brian Moynihan, President and CEO of the bank, cannot seem to get the bank's problems behind him.

After four years running the bank, he must accept the responsibility for not getting the problems behind him.

In my post on April 7, 2014 I wrote the following summary concerning Brian Moynihan, the leader of Bank of America (NYSE:BAC):

"Brian Moynihan became the President and Chief Executive Officer in January 2010, so he has been in the top position at the bank for a little more than four years. During the time he has been in this spot, the bank has not experienced the overall results it would have liked, yet the work Moynihan has accomplished seems to have the approval of the shareholders.

The bank itself seems to be coming along adequately. The problem, which the investors seem to accept, is that there are many severe hangovers from decisions made before he became CEO. Unfortunately, the hangovers do not seem to want to go away - Moynihan cannot get them behind him. Although a lot has been settled, the New York Times article cited above carries these ominous words concerning the bank's legal liabilities: 'there are other large pending cases that could weigh on future earnings.'"

One, we now know is the possibility of another possible legal bill that would include more than $16 billion in penalties to settle claims that Bank of America sold investors faulty mortgages. This settlement will be with the Justice Department.

Now, we get the news that Bank of America had been carrying an accounting error…since 2009…that overstated its capital…for regulatory purposes. The amount of the error…$4 billion.

Right off, we can make two points. First, the initial error came from 2009, a time when Mr. Moynihan WAS NOT the President and CEO. So, this error was just one more of "many severe hangovers from decisions made before he became CEO." Thank you Ken Lewis!

Second, the mistake had to do with regulatory accounting and did not have anything to do with the financial accounting connected with Generally Accepted Accounting Principles (GAAP). What the investment community saw was not misstated.

I am not going to go into all the specifics about the error for that has been well covered in the press: in the New York Times or in the Wall Street Journal.

The point is, a major "goof" was made…not in terms of the dollar amount of the adjustment, which in commercial banks of this size are minor…but, in terms of management control. The question becomes…who was managing the ship?

But, here things get a little fuzzier. The initial error was made in 2009. This means that at least five accounting cycles took place since then and the error was not caught. The error was only caught AFTER the last report was filed…and earnings were reported to the public.

Immediately, cries arose about whether or not these large banks were too big to manage. And, that may be the case, but I will come back to this a little later.

Here I quote from the New York Times writer Floyd Norris:

"It is clear that Bank of America management should have caught the error. Or, the Board's audit committee should have caught the error. But it is less clear who else should have caught it."

The two possible "catchers" are the regulators…in this case the Federal Reserve …or the bank's auditors…in this case PricewaterhouseCoopers. They, too, should have had at least five "shots" at finding the error. But, they didn't.

Maybe another question should be asked…are these large banks too big to regulate? And, another…are these large banks too big to audit?

There is no question in my mind that the bank's management should have caught the problem, right early on. They have the oversight responsibility and it is in their best interest to carry out this responsibility. They did not execute very well on this issue.

Next, the audit committee of the Board of Directors also bears some responsibility. Why have an audit committee of the Board if they do not carry with the duty, the responsibility to sniff out errors? Again, a failure.

Then, the next line of trust of management and the Board is the external auditing firm the bank hires to "cover the bank's back." Another failure.

I have been the president and CEO of two banks and the CFO of a third. When these banks went into a bank examination conducted by the regulators, I believed that it was my responsibility to have the bank in such good order that there would be no doubt in my mind that the examiners would not discover anything of major consequence.

And, this was a tough road to go down since the banks I was associated with were turnarounds.

But, it was my responsibility. That was my job! If anything, the banks I was associated with always erred on the side of being too cautious. Of course, I did not run a huge bank like Bank of America or any of the other giants. But, I still believe that the President and CEO…and the CFO…have the responsibility of exceeding the regulations that banks have to live by.

For a new CEO just taking over the position, you only have a relatively short time in order to move to get the bank under your control…and this is true even if the bank is in pretty good shape.

As far as the regulators are concerned…as good and well-meaning that they are…they will always be behind where the banks are…especially the large ones that deal in such complex and intricate assets and liabilities…and will tend to come up short.

Bank CEOs should not rely on the bank regulators or examiners to catch their errors!

As far as being able to manage large banks, I don't believe any bank is too big to manage. The CEO has the responsibility to create a culture that can manage the accounting, the risk, and all other things that go into bank operations. To me, it is still the responsibility of the CEO make decisions as to what the bank should be doing and what it shouldn't be doing. That is a part of the CEO's job! And, I believe that banks are going to get larger because the information technology will allow them to get bigger. So, CEOs are going to have to find out how to succeed.

In summary, I would argue that this latest "goof" has hurt shareholders in two ways. First, Bank of America must postpone any increase in its dividend payment and reduce or eliminate any stock repurchases it planned. But, this is the minor impact of the two.

Second, I believe that this episode is a real "black eye" for Mr. Moynihan. As I wrote in the previous post, "Unfortunately, the hangovers do not seem to want to go away - Moynihan cannot get them behind him." This is the fourth year at the helm of the bank. Maybe, after this amount of time, the "hangovers" are not just an unfortunate consequence.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.