Questions We Received from Bank of America Management — and Our Response

Over the last several years, we have written about the major red-flag issues we see on the balance sheets of the largest banks in the United States.  Recently, we wrote an updated article on BAC.  A few days later, a BAC executive sent us an email claiming that our article was “senseless” and “offensive.”  

Within their communication, they attempted to rebut 5 points we made in our article.  Therefore, we have decided to address these points publicly so that everyone can have a better understanding of our perspective regarding our views.

First and foremost, in our articles we highlight red flags or major vulnerabilities at the largest banks that could lead to severe issues in a crisis. We are not saying that BAC or other large US banks we discuss will fail tomorrow; i.e., in a normal and favorable environment, these issues are unlikely to cause a default. We are discussing a tail-risk scenario, or a stress scenario. And it would be a mistake to think that a tail-risk scenario will never materialize.  Yet, we do see it as a strong probability when the market moves into its next bear phase.

For example, we have written many articles about the Fed’s losses. The Fed said that the recent magnitude of its losses would materialize only in a tail-risk scenario. Yet it did materialize, and the losses were even bigger than in the Fed’s stress-test scenario. Another example concerns BAC itself. When BAC bought these HTM securities at very low yields, did it expect such a huge loss in its base-case scenario? Probably not. Otherwise, it would not have done so. The sharp rise in interest rates that led to these losses is a form of tail risk for BAC as well. 

Now, let’s discuss the points that BAC’s management has raised.

1. BAC says that “HTM securities are held to maturity and you know what happens when they mature - they pull to par.”

We agree that this point is valid in a base-case scenario. However, in a tail-risk scenario, the problem is not maturity value - it is liquidity. If a crisis comes, deposits and wholesale funding can leave or reprice very quickly, and BAC may need liquidity before these HTM securities mature at par. According to our own estimates, the average maturity of this HTM book is around 15 years.   So, we clearly stated the obvious in our previous article:

Needless to say, these deeply underwater HTM bonds cannot be sold or even repositioned without realizing a loss equal to roughly 40% of the bank’s capital.

BAC is also arguing that these HTM bonds are “held for duration purposes against a long duration deposit book of $2T that has immensely more value than the mark on HTM.”

Without any doubt, having a long-duration deposit book is excellent, but it only works in a normal environment. In a crisis, even the strongest deposit franchises can face severe issues, such as deposit outflows, sharp increases in deposit betas, and higher competition for deposits. In such a scenario, this narrative of “duration purposes against a long-duration deposit book” may no longer hold. At the end of the day, you cannot directly monetize your deposit franchise when you need immediate liquidity or capital.

2. BAC argues that in 12 of the last 13 CCAR exams, which are conducted by the Fed regulators, BAC has had the lowest stress loss ratios of any big bank.

We have written a lot about the Fed’s CCAR and the fact that even the assumptions in the regulator’s severely adverse scenario look very mild. The Fed expects a very short-lived scenario and a V-shaped recovery. 

Also, these are hypothetical calculations, and we would also like to remind readers that the Fed has not always been able to correctly forecast its own financial position.  In fact, Alan Greenspan – former Chairman of the Federal Reserve said this himself:  “We really can't forecast all that well, and yet we pretend that we can, but we really can't.”

In addition, in 2023, BAC made a statement saying that there were significant discrepancies between its own calculations and the 2023 stress test results released by the Fed. First, BAC’s internal stress test showed that the bank would post a loss of $52.2B under the severely adverse scenario, while the Fed expected the bank to lose only $23.0B. Second, BAC estimated that its OCI would be $12.5B, while the Fed’s tests showed it would be $22.3B. Due to a combination of a bigger loss and lower OCI, BAC expected its CET1 capital ratio to fall to 8.3%, while the Fed said the ratio would decline to 10.6%.

3. BAC says that they “are somewhere currently on loss ratio between zero where it has been for years and historical lows.”

First, some segments are clearly not “near zero” (e.g., credit cards 3.68%, small business commercial 2.44%, CRE 0.74%). Second, we are not saying that BAC is in acute credit distress right now. The fact that current loan loss ratios are relatively low does not refute vulnerability to cyclical credit deterioration. Loan loss ratios are rising even in this relatively benign environment, so one can imagine how they could rise sharply if a severe crisis were to occur, especially given BAC’s loan mix, with a focus on commercial lending and unsecured retail lending.

4. BAC says that they “have $20B of sales and trading revenue and we are the only firm that has ever had 15 straight quarters of YoY sales and trading growth - sounds pretty consistent and stable and highly profitable.”

Capital markets revenues cannot remain consistent and stable forever, as they are inherently market-dependent. There are many things that can happen to capital markets revenues in a crisis environment, such as much lower client activity, trading losses, counterparty defaults, and collateral issues.

5. BAC argues “that CET1 capital of $201B and CET1 ratio [provide] a ton of excess over the minimum ratio. And by the way $25B is a lot of excess capital and more than most banks even have in total capital.”

In a crisis scenario, this capital can be consumed very quickly, given the vulnerabilities or red flags we discussed in our previous article, especially because a crisis shock is most likely to be multifactor. Depending on the severity and combination of shocks, this $25B buffer could come under significant pressure in a relatively short period of time. That point is important even before considering RWA movements, which could also be significant in a crisis. In other words, the issue is not only the starting level of excess capital, but also how quickly losses and RWAs can move under stress.

6. BAC says that they “have one of the lowest costs of deposits in the industry at 2.14% and one of the most stable and growing deposit bases!”

Many US banks have lower deposit costs, which can be easily checked in publicly disclosed information. More importantly, the recent period of high rates showed that BAC no longer has a low deposit beta. So, if a funding shock occurs, BAC’s cost of deposits could increase sharply, while its HTM book would continue to generate the same low yield.

Finally, we believe it is important to note that BAC did not attempt to rebut several other issues we highlighted, including: (a) BAC’s significant exposure to international lending, which introduces not only credit risk but also FX and sovereign risks; (b) significant exposure to unsecured retail lending; and (c) operating efficiency concerns, even with strong market-related revenues.

I want to conclude this section by noting that we gave BAC an opportunity to respond to our points, and they declined.

The Bottom Line

As our analysis shows, only some areas of BAC's balance sheet have improved since 4Q09, while others have deteriorated significantly. As such, it's wrong to say that BAC's balance sheet and its overall business model are better prepared for a crisis compared to the pre-Great Recession period.

We did not discuss all the problems that BAC has, but even the issues we have mentioned could eat up the bank's capital quite quickly if a major systemic crisis comes to pass.

I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you that BAC is not alone regarding major concerning issues sitting on the balance sheets of those banks. The substance of our analysis suggests that the future is not looking too good for the larger banks in the United States, details for which are here.

Moreover, if you believe that the banking issues have been addressed, I'm sorry to inform you that you likely only saw the tip of the iceberg. We were able to identify the exact reasons in our public article which caused SVB to fail, well before anyone even considered these issues. And I can assure you that they have not been resolved. It's now only a matter of time.

At the end of the day, we're speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money.

You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And if you're relying on the FDIC, I suggest you read our prior articles, which outline why such reliance will not be as prudent as you may believe in the coming years.

It's time for you to do a deep dive on the banks that house your hard-earned money in order to determine whether your bank is truly solid or not. For those looking for a due diligence methodology, our due diligence methodology is outlined here.

You can also choose to join our website saferbankingresearch.com wherein we have outlined the safest 15 banks in the United States based upon our research, along with some of the top banks in various states, the safest trading platforms, along with the safest banks in Canada and the Eurozone.