The Dow's Banks Take a Hit for Bank of America's Blunder

Banks in the Dow Jones Industrials underperformed the market. Was B of A's capital-calculation mistake to blame?

Apr 28, 2014 at 9:05PM
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Monday brought back good news for the Dow Jones Industrials (DJINDICES:^DJI), which gained 87 points in an impressive recovery from a midday swoon that had carried the Dow into negative territory briefly. Yet within the Dow, Goldman Sachs (NYSE:GS) and JPMorgan Chase (NYSE:JPM) both posted declines, as the dour mood created by Bank of America (NYSE:BAC)'s plunge today carried over to its peers as well. Were investors right to sell off the entire financial sector, or were Bank of America's problems isolated within its own organization?

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The scope of the problem
Bank of America plunged 6% as the bank announced that it had made an error in calculating its capital reserves. Apparently, B of A made a mistake in accounting for structured-note products that its Merrill Lynch division had issued prior to its acquisition. The bank cited an "incorrect adjustment" in determining how much regulatory capital was necessary and how to treat realized losses on notes that had already matured or were redeemed by Bank of America.

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As a result of the miscalculation, Bank of America had to suspend its planned $4 billion stock repurchase and its expected quintupling of its quarterly dividend to $0.05 per share. Once B of A's board of directors approves recalculated numbers, the Fed will have an opportunity to approve Bank of America's revised capital-action requests. But Bank of America said that it expected its final capital actions to be smaller than those previously announced.

But is it anyone else's problem?
There's no questioning that Bank of America deserved to see a share-price decline, as its investors had long awaited a boost in returns of shareholder capital and therefore stood to lose a lot from the suspension of dividends and buybacks. But why did Goldman Sachs and JPMorgan Chase fall?

Interestingly, as the Wall Street Journal reported late this afternoon, JPMorgan Chase has much more exposure to the structured-note market, and therefore, if there were a problem with structured notes specifically, then today's slightly decline for JPMorgan would make sense. But there's no indication that anyone other than Bank of America has improperly accounted for structured notes in their capital calculations, and that makes the sell-off for JPMorgan and Goldman Sachs seem like a kneejerk reaction that's unwarranted by the facts.

Moreover, treating banks as a group increasingly misrepresents the different moves they've made to rein in risk. For instance, JPMorgan Chase announced today that it has cut back on its intraday repo-market credit exposure, addressing one of the sources of systemic risk that many have seen as a potential cause of a future financial crisis. Goldman Sachs, meanwhile, has made numerous moves to reduce its overall leverage, and while that has arguably hurt profits, it should have made the shares safer from an investor's standpoint.

In all likelihood, today's punishment of bank stocks was unfair for all except Bank of America. The idea that B of A's blunder will prompt greater regulation overall seems farfetched, especially given the rapidity with which Bank of America took steps to remedy the situation.

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Dan Caplinger owns warrants on Bank of America and JPMorgan Chase. The Motley Fool recommends Bank of America and Goldman Sachs and owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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