The Wall Street Journal-20080123-breakingviews-com - Financial Insight- BofA Is Looking Like Rival- After Distancing Itself From Citigroup- Bank Has Similar Write-Downs
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breakingviews.com / Financial Insight: BofA Is Looking Like Rival; After Distancing Itself From Citigroup, Bank Has Similar Write-Downs
Kenneth Lewis in recent years has distanced his bank from Citigroup. While Citigroup floundered, the Bank of America boss pounced, buying such businesses as U.S. Trust and LaSalle Bank, and engineering a bargain-basement price for mortgage lender Countrywide Financial. Bank of America has even leapfrogged Citigroup to become America's largest bank by market value. Now it is looking more like its New York rival.
One resemblance is in the realm of structured product write-downs. Bank of America's troubles aren't as big. It took a $5.4 billion hit in the last quarter of 2007 and has $12 billion of exposure left to subprime mortgage-related securities -- each roughly a third of Citigroup's equivalent numbers. Still, the Charlotte, N.C., financial- services concern had to rely on one-time gains to eke out a meager profit.
Acquisitions have come back to haunt it, as they have Citigroup. The purchase of LaSalle gave BofA access to the coveted Chicago-area retail market, but it also bumped up its problem loan book. Bank of America also paid the $21 billion price in cash. Combined with the write-downs, that has left the bank's tier one capital ratio -- a measure of a bank's capital cushion -- languishing at 6.9%. That is above minimum regulatory requirement of 6%, but well below Mr. Lewis's 8% target.
Citigroup's new boss, Vikram Pandit, has had to go hat in hand twice to cash-rich overseas investors for new equity to bolster his bank's capital. Mr. Lewis also needs to raise money. But he may have one regret not shared by his counterpart. Bank of America once held roughly $16 billion of insurance-like trades that would have been profitable amid the credit crunch. Most were dismantled after a 2005 change of leadership at the company's investment bank. Just think what a difference keeping them could have made.
Bond Insurers' Woes
New York regulators are scrambling to head off a meltdown that would trigger higher costs for municipal-bond issuers and losses for bond investors. A credit-rating downgrade last week of Ambac, the second- largest bond insurer, and the $31.85-a-share loss it reported yesterday have added to the urgency. There is talk of a bailout. But there is a more straightforward solution. Regulators should just bar the bond insurers from insuring structured products.
Companies like Ambac and MBIA started off backing municipal debt, a business that still accounts for the bulk of their activities. Muni bonds rarely run into trouble -- the default rate is less than 1%. But municipal issuers have a hard time getting top ratings, because they aren't well-diversified and their bond issues tend to be small. So the bond insurers, in return for fees, provide insurance that enables muni bonds to get a higher rating but that doesn't saddle the insurers with a lot of credit risk. As a result bond insurers hold much less capital than, say, banks.
In recent years, they applied that model to structured debt instruments such as collateralized debt obligations. It is proving disastrous. Estimates of the creditworthiness of CDO securities, especially those backed by subprime mortgages, were too optimistic. So despite insuring only highly rated CDO securities, the bond insurers actually took on a lot of risk.
Barring muni-bond insurers from backing any more structured products would have a few benefits. The muni market would be better shielded from shocks elsewhere. And underwriters and ratings providers would have to do much more work explaining snazzy new products to investors, rather than relying on bond insurance backstops. That might lead to more-conservative deal structures and pricing.
Moreover, bond insurers' long-suffering shareholders also could benefit. They would know for certain the extent of each insurer's exposure to structured products, which would decline over time. Insuring muni bonds may sound dull, but it could be the shareholders' best bet.
-- Antony Currie and Dwight Cass
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This column is by breakingviews.com, an online financial commentary site.
